Activity based Costing( ABC)

Definition: Activity based costing is a managerial accounting method that traces overhead costs to activities and then assigns them to objects. In other words, it’s a way to allocate indirect, overhead costs to products or departments that generate these costs in the production process.

What Does Activity Based Costing Mean?

What is the definition of activity-based costing? ABC costing focuses on identifying activities, or production processes, that are used to process a job. These individual activities are grouped together with similar processes into a cost pool that relates to single activity driver

The cost pools are then analyzed and assigned a predetermined overhead rate that will eventually be assigned to individual jobs and products.

As you can see, this is a multi-step process, but activity-based costing is a much more accurate way of assigning indirect costs. It’s difficult to determine how much electricity or heat one department or job uses over another without some type of methodical allocation process.