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Activity-Based Costing

Activity-based costing (ABC) is a cost allocation methodology that assigns overhead and indirect costs to products, services, or customers based on the activities they actually consume, rather than using broad allocation bases like revenue or headcount. ABC identifies the specific activities that drive costs — such as order processing, quality inspection, or machine setup — and traces those costs to the outputs that trigger them. This produces more accurate product and customer profitability than traditional costing methods, particularly in businesses with diverse product lines or service offerings.

Why This Matters

Traditional cost allocation often spreads overheads using a single driver — revenue, headcount, or direct labour hours. This works when products and customers are similar. It fails when they are not. For mid-market companies with growing product complexity or diverse customer segments, the distortion compounds over time: some products subsidise others invisibly, and pricing decisions are built on flawed cost data. ABC corrects this by connecting costs to the activities that actually cause them.

Where This Fits

This term sits within the Performance & Profitability area of Performance & Control.

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