In Activity Based Costing (ABC), the entity identifies the activities which are responsible for manufacturing overheads. This is a different approach from the traditional one as the old one usually allocates overheads on the basis of machine hours or direct labour hours.
ABC is mostly applied in a manufacturing company because its implication over other sector is quite impracticable such as apportionment of staff salaries. This costing method is considered as one of the most logical methods as it charges overheads to activities which demand these resources.
In Activity based costing, we allocate overheads to different cost pools. After that, we divide the cost pool by the relevant cost driver. As a result, we get a rate which we can use to allocate manufacturing overheads to various products.