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What Is Activity-Based Costing (ABC)?

  • Identify all activities required to create a product.
  • Divide activities into cost pools (e.g., manufacturing).
  • Calculate total overhead for each cost pool.
  • Assign cost pool activity cost drivers (e.g., hours or units).
  • Calculate the cost driver rate (total overhead divided by total cost drivers).
  • Multiply the cost driver rate by the number of cost drivers.

ABC provides more accurate cost data, especially in manufacturing, resulting in better pricing strategies and profitability analysis.