An activity-based costing system is an accounting system that majors on controlling the cost of a company. This is done by reducing and controlling costs to ensure quality is achieved at the most minimal cost possible. To be able to control cost, one needs to identify cost drivers that one can use to control cost. To be able to control cost, manufacturing companies use activity bases like direct material that are allocated costs. This activity bases help them control costs and make sure they are within a profitable range.
Unlike manufacturing companies, service companies do not have an inventory that can be used to control costs. Direct materials and direct labor are not among the major cost bases in the service industry. This makes it difficult to calculate standard costs and rates for use for costing in the service industry. Service industries do not need accurate costs for productivity analysis. Services industries are more concerned with determining what services are more profitable, what products should be placed more emphasis, and also analyze the profitability trend with time. Service businesses like banks make more profits, not on the number of customers that they serve but on the number of transactions they make. This means that a bank needs to identify a product that has more transactions and major on that as it is more profitable. This means other than concentrating on direct material and labor as for manufacturing companies, service companies are more concerned with getting a product that will generate more revenue than the others.
This means that in the service industry, a business needs to be more futuristic to be able to tap into products that will generate more revenue for the business. Activity-based costing is a tool that helps businesses to achieve this objective. The goal of activity-based costing is to measure and then price all the visible and invisible products used to offer a service and assign a cost.