What type of costs does Activity Based Costing typically use?

Activity Based Costing (ABC) is a method that prioritizes the identification and allocation of costs based on the activities involved in the production of goods or services. This approach allows organizations to trace both direct and indirect costs to the specific activities that generated them.

Direct costs include expenses that can be directly attributed to a specific product or service, such as raw materials and labor directly involved in production. Indirect costs, often referred to as overhead, encompass all other costs that are not directly linked to a specific product. These can include utilities, rent, and salaries of supervisory staff, which are crucial for the business operations but do not tie directly to specific production activities.

By utilizing both types of costs and linking them to activities, ABC provides a more nuanced and precise understanding of where resources are being consumed within an organization. This leads to better insight into cost management and pricing strategies, ultimately supporting more informed decision-making processes. Comprehensive cost analysis is crucial for efficiency improvements and profitability assessments, making this dual-cost approach essential for accurate financial reporting and strategic planning.