How to Easily Calculate Activity Based Costing
Last updated: 28th July 2025
First published: 16th May 2023
Even if you haven’t heard of activity-based costing, you’ve probably already conducted this activity in your business.
Activity based costing (ABC) simply means calculating the cost of running a business process. ABC is a powerful accounting methodology that provides a more accurate way to understand the true costs associated with producing products or delivering services.
This is particularly useful as it enables you to perform a variety of tasks, from identifying lean waste in your processes to providing data to support business cases for your stakeholders.
In this blog, we’ll take a look in more detail at the fundamentals of activity-based costing and some of the tools you can use in your business to understand your own costs. Ready to learn more?
In this article, we’ll answer the following questions for you:
What is activity-based costing?
Fundamentally, activity-based costing (ABC) is a calculation of the aggregate cost of activities in a process. It considers the total cost of running that process, from materials, to time, people and movement. For anyone looking to understand their company’s finances, ABC produces nearly true costs and classifies them accurately.
Activities are essentially anything that is a cost driver or has a cost, such as purchase orders, machine setups or training sessions. They are any event or task that has a specific goal. You add up the costs for each to arrive at the total cost. And you’ll find out what you are spending too much on, whether that’s money or time.
Additionally, overhead and indirect costs, such as salaries and utilities, can be assigned to specific products or services to keep them in mind when calculating costs. ABC also enables companies to have a clearer understanding of their pricing strategy. They want to (at the very least) break even in what they generate versus what they spend on.
Activity-based bosting Vs traditional costing
Traditional costing systems typically allocate overhead based on a single metric, like labour hours or machine time. While that works in some cases, it can oversimplify costs and misrepresent the actual cost of products or services.
ABC, on the other hand, asks and helps you get a more detailed answer:
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What activities do we perform to deliver our products/services?
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How much does each activity cost?
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Which products or services consume these activities?
Why is activity-based costing important for your business?
ABC is important for any business because it helps you to keep track of how much it costs you to run it, versus how much revenue you are generating. You don’t want to spend blindly on tools or purchases that are not producing fruit for how much they are costing you.
Consider a task in your business that’s constantly being repeated because of errors. Perhaps a process regularly bounces back to a previous step because information is missing. This means hours of employee time are being wasted – time that could be dedicated to more valuable projects.
In a similar vein, you can also think of automation.
Organisations routinely face time-consuming manual tasks, such as logging appointments, drafting follow-up emails, or populating CRM fields. Consider the hours spent simply moving data between spreadsheets, your CRM, and email marketing tools. These are not just time sinks; they drag down overall process efficiency. As an organisational leader, this represents lost potential, diverting valuable hours that could be dedicated to high-impact, revenue-driving initiatives.
ABC directly addresses this challenge by exposing these inefficiencies with concrete, numerical data. Using the ABC framework, you can consistently evaluate your processes to understand their true cost and profitability. You can then model potential improvements numerically, for example, eliminating a redundant step and automating a specific activity.
ABC also enables you to precisely calculate the time saved and the potential cost of automation using various tools. Presenting these clear, data-backed projections makes it significantly easier to gain buy-in from both stakeholders and employees for necessary process changes.
When is activity-based costing useful?
While highly beneficial, ABC is not a one-size-fits-all solution. It’s particularly useful in certain businesses that:
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Have high indirect costs: Businesses with a significant proportion of their total costs tied up in overhead or indirect expenses will find ABC especially valuable, as it can shed light on where that money is truly going.
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Have diverse product or service offerings.
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Have complex operations: Businesses with complex production processes, multiple departments, and numerous activities will find ABC effective in disentangling their cost structures.
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Pressure to reduce costs: If there’s a strong mandate for cost reduction, ABC helps identify the specific activities that are consuming the most resources and where efficiency improvements can have the greatest impact.
What are the six steps in activity-based costing?
To calculate ABC, you must follow these steps:
Step 1: Map out your processes and key activities
Start by listing all the major activities your business performs, such as production runs, quality inspections, customer support, packaging, and shipping.
Step 2: Assign costs to activities
Next, assign all your overhead costs (indirect labour, utilities, depreciation, etc.) to these activities. This might involve tracking hours worked, the number of transactions, or the space used.
Step 3: Determine cost drivers
Cost drivers are the factors that cause activities to consume resources. For example:
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Machine hours for manufacturing
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Number of orders for fulfilment
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Customer support calls for service
Choose cost drivers that accurately reflect the consumption of resources.
Step 4: Collect activity data
Gather data on how much each product or service uses the cost drivers. This could involve historical records, ERP data, or employee time logs.
Step 5: Calculate activity rates
Divide the total cost of each activity by the total units of its cost driver. This gives you a cost rate per unit of activity. For instance:
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$10 per machine hour
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$5 per customer support ticket
Step 6: Assign costs to products or services
Finally, apply these activity rates to the actual usage by each product or service. This provides a clearer and more accurate view of the true costs.
You can then plug the above information into the following formula:
Activity Cost = (Duration x Hourly Cost of Employee Responsible) + Direct Costs
An example of activity-based costing in action
Let’s say you run a company that produces two products: Deluxe chairs and standard chairs.
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Traditional costing assigns the same overhead per unit based on labour hours.
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However, deluxe chairs require more rigorous quality checks, longer production times and specialised packaging.
Using ABC, you’d find deluxe chairs consume:
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3x the inspection time
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2x the setup hours
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4x the packaging materials.
With this insight, you might realise deluxe chairs are much less profitable than you thought, or that you need to adjust their pricing or reduce production costs.
While the value of ABC is clear in cases like this, managing all those cost drivers and data points manually can quickly become overwhelming. That’s where ABC software comes in.
What is activity-based costing software?
Activity-Based Costing software is designed to give you a clearer picture of where your resources are really going. While ABC itself offers valuable insights, doing it manually is often slow, error-prone, and difficult to scale, especially in larger or more complex organisations.
ABC software automates the key steps: data collection, activity mapping, cost allocation, and reporting. It pulls data from your existing systems, applies cost logic, and generates detailed breakdowns to help you make smarter, more informed decisions.
How activity-based costing software works
Activity-based costing software helps you understand the true cost of your operations by combining data, logic, and automation. Here’s how it works:
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Data integration: Connects to your systems (accounting, ERP, HR, etc.), and pulls in data like costs, time logs, and transaction volumes
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Activity mapping: Define the activities, cost pools, and cost drivers within the tool
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Cost allocation: Software applies formulas to assign costs to activities and then to products/services
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Analysis and reporting: Visual dashboards show cost breakdowns, profit margins, and trends
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Scenario testing: Easily simulate business changes and their financial impact
Top examples of ABC software include Liberty Spark, which simplifies the entire process from mapping to analysis.
Advantages of ABC software
Implementing ABC with dedicated software offers a multitude of advantages:
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Increased accuracy and reliability: Software eliminates manual calculation errors, ensuring that cost assignments are precise and reliable. This leads to more trustworthy financial data for decision-making.
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Time and cost savings: Automating data collection and calculations drastically reduces the time and effort required to perform ABC. This frees up financial professionals to focus on analysis and strategic insights rather than tedious data entry.
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Enhanced data management: ABC software provides a centralised repository for all cost-related data, making it easier to store, retrieve, and manage large datasets.
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Improved reporting and analysis: These tools provide powerful reporting features, enabling users to generate customised reports, dashboards, and visualisations. This facilitates the interpretation of complex cost data, identification of trends, and effective communication of insights.
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Scalability: As your business grows and its operations become more complex, ABC software can scale to accommodate increased data volumes and more intricate costing models.
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“What-if” scenario analysis: Many ABC software solutions allow users to perform “what-if” analyses. You can model the impact of changes in activity volumes, cost driver rates, or process improvements on product costs and profitability, aiding strategic planning.
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Greater transparency: The structured nature of ABC software provides a transparent view of how costs are allocated, making it easier to understand the drivers of profitability and identify areas for improvement.
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Integration capabilities: Modern ABC software can often integrate with other business systems, such as Enterprise Resource Planning (ERP) systems, general ledgers, and operational databases, ensuring a seamless flow of data.
Activity-based costing with Liberty Spark
Liberty Spark is our process improvement solution that simplifies processes for all parties involved and serves as a platform dedicated solely to business process mapping. You no longer need to rely on piecing together several tools to map out your process, nor do you need to fear any miscommunication as a standardised platform with Universal Process Notation (UPN).
Introducing Liberty Spark’s Quantify tool
For ABC, Liberty Spark offers a collaborative, cloud-based platform designed to map out your existing business processes with ease. It’s simple to involve all relevant team members, allowing them to visualise and contribute details about the tasks they perform daily.
Once your process is mapped, you can enrich it with crucial information, such as:
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Time taken for each task
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Direct costs linked to steps
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Hourly rates for the roles involved.
With this data entered, our Quantify feature automatically calculates the ABC for you, eliminating manual work and potential human errors.
The main dashboard provides an instant overview, showing you the total weekly cost of the entire activity. You’ll see a clear breakdown of fixed costs versus role-based costs, and quickly identify your most expensive activities and roles. More in-depth analysis is always available, with all numbers generated as soon as your data is in.
And when it comes time to justify changes to stakeholders, Quantify is your powerful ally. It helps you prepare a comprehensive business case, presenting all relevant data, calculations, and forecasts in an easily understandable format. This makes getting buy-in and faster sign-off on your proposed changes much simpler.
Turn process insight into smarter financial decisions
Ultimately, Activity-Based Costing, powered by Spark, provides a nuanced way to reconsider your spending. It moves beyond simple cost-cutting measures, allowing you to identify precise areas for improvement and make smarter, data-driven financial decisions.
Want to see how Liberty Spark makes ABC effortless?
If you’d like to learn more about how Liberty Spark can help you effortlessly calculate ABC going forward, don’t hesitate to get in touch with our team today.
