Activity-based costing is a technique of costing based on activities. Traditionally this technique is used to allocate indirect or overhead costs to cost objects, products or customers in a more accurate way. But Activity Based Costing is more than “just” a technique to allocate indirect cost more accurately. As a technique it can be used to provide a wide range of information that enables managers to achieve many important goals: improved customer and product profitability; cost reduction; process re-engineering; capacity management; continuous re-forecasting and budgeting.

An ABC model typically has the following structure:

Overhead Cost Management and Reduction

The difficulty with cost of overheads and indirect activities is that much of what they do is not directly visible to others. If the service they give falls, or if overtime increases, or if the backlog of work rises, managers in the overhead areas will bid for more resources to tackle these problems, which are usually symptoms of a volume increase. But when volumes fall, managers seldom argue that they are over-resourced. This results in 'invisible' spare capacity in the overhead.

An ABC model identifies the activities and outputs of the overhead areas and estimates the resource needed to accomplish each one. An ABC model can determine what influences the volumes of activities and outputs the overhead areas have to tackle.