A managerial cost-accounting technique that assigns indirect and overhead costs to products, services or customers by tracing those costs to the specific activities that consume resources and then using activity drivers to allocate activity costs to cost objects.

Principle

Costs are driven by activities: by grouping costs into activity cost pools and selecting measurable cost drivers that reflect resource consumption, overhead can be allocated to outputs in proportion to the activities they require.

Demonstration

Illustrative scenario: A factory records machine setup time as an activity cost pool. Setup-related costs (setup labor, fixtures) are pooled and allocated to product families using number of setups as the driver; products requiring more setups receive a larger share of setup overhead, changing per‑unit cost compared with a simple volume-based allocation.

Misapplication

Using arbitrary or poorly correlated drivers (e.g., allocating setup costs by units produced when setups are independent of volume) or implementing ABC at excessive granularity without sufficient data — errors that produce misleading cost signals and high maintenance cost.

Consequence

Applied correctly, ABC improves visibility into cost causation, enabling better pricing, product-mix and process-improvement decisions; it increases costing accuracy at the expense of data collection and analytical effort and can materially change perceived profitability of offerings.

Reversal

When indirect costs are small relative to direct costs or when products are homogeneous and overhead consumption correlates closely with a simple volume measure, the benefits of ABC may not justify its implementation cost; regulatory financial reporting may still require conventional allocation methods regardless of ABC results.

Boundary

Clearly within: managerial costing for pricing, product-mix and process decisions where overhead is material and activities vary across outputs. Boundary case: service firms with intangible activities that are hard to measure reliably. Clearly outside: statutory financial statements prepared under accounting rules that prescribe specific allocation bases for external reporting.

Semantic Tension

Allocation accuracy (assigning costs to their causes) ↔ Practical cost and data burden (effort, timeliness and understandability); higher assignment fidelity increases decision usefulness but also implementation and maintenance cost.

Synthesis

ABC makes causal links between resources, activities and outputs explicit; its value lies in revealing which activities drive cost so managers can target process changes or repricing, but its usefulness depends on choosing drivers that genuinely reflect consumption and on weighing the analytical cost against decision value.