Activity-Based Costing (ABC) is a costing method that assigns overhead costs to products or services based on the activities that create those costs.

Simple Meaning:

ABC calculates product cost by identifying the work (activities) involved and then assigning costs based on actual usage.

How It Works:

Identify activities (machine setup, inspection, packaging, etc.)

Determine the cost of each activity

Find cost drivers (number of setups, inspection hours, etc.)

Allocate costs to products based on activity usage

Example:

If Product A requires more machine setups than Product B, Product A will be assigned more setup costs under ABC.

Benefit:

More accurate product costing

Better pricing decisions

Helps control overhead costs

In short, Activity-Based Costing assigns costs based on what actually causes the cost, not just on simple measures like labor hours.