What is activity-based costing (ABC)?

Activity-based costing (ABC) is a costing methodology that assigns costs to products or services based on the activities involved in their production or delivery. Unlike traditional costing methods that allocate overhead costs based on arbitrary allocation bases such as labor hours or machine hours, ABC identifies the activities that consume resources and allocates costs based on the drivers of these activities. ABC involves the following steps: identifying activities, determining the cost drivers for each activity, tracing costs to activities, and allocating costs to products or services based on their consumption of activities. By providing more accurate cost information, ABC enables better decision-making regarding pricing, product mix, process improvement, and resource allocation. It helps organizations understand the true cost drivers of their products or services and promotes efficiency and cost optimization.