Activity-Based Costing (ABC)

Activity-Based Costing (ABC) is a costing method that identifies the activities an organization performs and assigns the cost of each activity to products and services based on actual consumption. Instead of broadly allocating overhead, ABC links indirect costs to the specific activities that drive them, providing a more granular and accurate view of cost incurrence. This approach helps businesses understand the true profitability of individual products, services, or customers.

By tracing operating expenses through activities to cost objects (like products or customers), ABC provides superior insights compared to traditional cost allocation methods. For example, it can reveal that a low-volume, complex product consumes a disproportionate amount of support resources, making it less profitable than previously thought. These insights are critical for strategic decisions, such as pricing, process improvement, and creating a more accurate financial model for planning.