Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. It is a system that tallies the costs of overhead activities and assigns those costs to products. ABC is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.

Here are some key points to understand about activity-based costing:

• ABC assigns overhead costs to products based on the activities that are the real cause of the overhead.
• It breaks down overhead costs between production-related activities and assigns costs to each activity that goes into production.
• ABC recognizes that certain activities cause costs and calculates the cost of the resources used in each of these activities.
• It assigns the cost of each of these activities only to the products that demanded the activities.
• ABC is used in target costing, product costing, product line profitability analysis, customer profitability analysis, and service pricing.
• It is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy.
• ABC benefits the costing process by expanding the number of cost pools that can be used to analyze overhead costs and by making indirect costs traceable to certain activities.

Although ABC gives accurate production cost details, it can be difficult to implement. It is best used in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out. Conversely, it is of less use in a streamlined environment where production processes are abbreviated, so that costs are easy to assign.