What does Activity Based Costing involve?

Activity Based Costing (ABC) involves a method of allocating overhead costs based on specific activities required to produce a product or service. This approach recognizes that not all overhead costs are incurred equally; various activities within an organization consume resources differently. By focusing on activities as the fundamental cost drivers, ABC allows for a more accurate allocation of costs to products or services based on the actual consumption of resources.

This method contrasts with traditional costing methods, which may allocate overhead based on a single metric, such as labor hours or machine hours. ABC provides a more nuanced understanding of where resources are spent and helps in identifying more precise cost information. This can lead to better pricing strategies, improved product profitability analysis, and enhanced decision-making regarding resource allocation and operational efficiency.

In the context of the other options, estimating overhead costs, budgeting, and cost-cutting strategies are not specifically about allocating costs based on activities but rather focus on different aspects of financial management or operational efficiency.