Activity-Based Costing (ABC) is a costing methodology that identifies and assigns costs to activities based on their use of resources, and then allocates those costs to products or services based on their consumption of those activities. This approach provides a more accurate picture of the true cost of producing a product or delivering a service compared to traditional costing methods.

In ABC, activities are the fundamental cost drivers. For example, activities like machine setup, quality inspection, or packaging consume resources and incur costs. ABC assigns these costs to products based on the extent to which each product uses these activities. This allows for a more precise distribution of indirect costs (overheads), rather than simply allocating them based on volume metrics such as direct labor hours or machine hours.

ABC is particularly useful in complex or diverse production environments where overheads are high and products vary significantly in the resources they consume. It helps businesses identify inefficiencies, eliminate non-value-added activities, and make better pricing, outsourcing, and process improvement decisions.

In summary, Activity-Based Costing enhances cost accuracy and supports strategic decision-making by providing deeper insight into what drives costs and how they relate to specific products, services, or customers.