In one sentenceA method that allocates overhead to products according to the activities they actually consume, such as the number of setups or orders, instead of one rate for all.
Simply put
A single rate (such as labor hours) can be unfair to products: an item produced in small batches that needs frequent machine setups costs more than it appears.
In this method you split costs into activity cost pools (setup, inspection, purchasing…) and each activity has a cost driver; then each product is charged according to what it consumed.
Worked example
In a confectionery factory, machine setup costs 20,000 SAR for 40 setups a month. Product B needed 30 setups and Product A 10 setups.
Cost per setup = 20,000 ÷ 40500 SAR
Product A's share = 10 × 5005,000 SAR
Product B's share = 30 × 50015,000 SAR
Setup cost charged to Product B15,000 SAR
Formula: Activity cost ÷ Number of driver occurrences, then × what each product consumed
Don't confuse it with
Overhead absorption rateThe traditional rate is one for the whole factory or department, while ABC has a rate for each activity.