What is the significance of activity-based costing (ABC)?

Activity-based costing (ABC) is significant because it allocates costs based on the actual activities that drive those costs, leading to more accurate product costing. This method recognizes that not all overhead costs are directly tied to volume-driven metrics like machine hours or labor hours. Instead, ABC assigns costs based on the specific activities required to produce a product or service, considering various factors such as setup time, inspection processes, and material handling.

This detailed approach provides management with important insights into how resources are consumed, helping in identifying non-value-adding activities and potential areas for cost reduction. By focusing on the actual drivers of costs, firms can better understand profitability on a per-product basis, facilitating more informed decision-making regarding pricing, product line management, budgeting, and resource allocation.