Use ABC when you need to understand why costs occur and which products, services, or customers are truly driving them. It won't fix every problem, but it will stop you from subsidizing unprofitable products with profitable ones—a mistake that can slowly kill a business. Traditional costing asks, "How much overhead did we spend?" ABC asks, "What activities did we do, and which products required them?" If you'd like a one-sentence summary for your notes: Activity-Based Costing (ABC) assigns overhead costs to products based on the specific activities (e.g., setups, inspections) each product requires, rather than using a simple volume-based measure like labor hours.
| Cost Pool (Activity) | Total Cost | Cost Driver | Chairs (usage) | Cabinets (usage) | | :--- | :--- | :--- | :--- | :--- | | Machine Setup | $100,000 | # of setups | 10 setups | 90 setups | | Quality Inspection | $80,000 | # of inspections | 200 inspections | 800 inspections | | Material Handling | $50,000 | # of moves | 50 moves | 150 moves | activity based costing meaning
Product A is overcosted (looks less profitable than it is). Product B is undercosted (looks more profitable than it is). Bad decisions follow. What is Activity-Based Costing (ABC)? Activity-Based Costing (ABC) is a costing method that assigns overhead and indirect costs to specific products or services based on the actual activities that drive those costs. Use ABC when you need to understand why
Cabinets cause most setups and inspections, so they get much more overhead. Chairs get less. | Cost Pool (Activity) | Total Cost |