Activity-Based Costing (Abc)

In accounting, activity-based costing (ABC) is a system that assigns manufacturing overhead costs to products on the basis of their activities.

The cost of each activity is assigned to all products that use that activity. The products are then charged for their share of the cost of each activity. This approach provides a more accurate allocation of manufacturing overhead costs than traditional methods, such as process costing or job-order costing.

Under ABC, manufacturing overhead costs are classified into different activities, and a cost pool is created for each activity. The manufacturing overhead cost per unit of output for each product is then calculated by taking the total cost in the relevant cost pool and dividing it by the number of units produced.

For example, suppose a company has three products: A, B, and C. The company has two production departments: assembly and finishing. Further assume that the company has identified five activities associated with its manufacturing process: machine setup, production run, inspection, packaging, and shipping.

The company would create five separate cost pools under ABC—one for each activity—and assign the costs in each pool to the products based on how much they use each activity. So if product A requires 2 minutes of machine setup time, 5 minutes of production run time, and 3 minutes of inspection time per unit produced; product B requires 1 minute of machine setup time, 4 minutes of production run time, and 3 minutes of inspection time per unit produced; and product