It is a method which precisely allocates the overheads to those items that actually use it. Activity-based costing is a method of assigning indirect costs to products and services which involves finding the cost of each activity involved in the production process and assigning costs to each product based on its consumption of each activity. It is a more refined approach than traditional costing. Process in ABC:
a) Identify those activities which are involved in the production.
b) Classification of each activity according to cost hierarchy.
c) Identify and accumulate the total cost of each activity.
d) Identify the most appropriate cost driver.
e) Calculation of total units of the cost driver relevant to each activity.
f) Calculation of the activity rate i.e. the cost of each activity per unit of its relevant cost driver.
g) Application of the cost of each activity to products based on its activity usage by the product.
Customer Profitability Analysis is best conducted with the ABC method. It let the company know about the profit that is coming from each customer. All the cost like manufacturing, selling, marketing, service and other costs are deducted from revenue to know the profit.