ABC is an alternative to traditional budgeting, where a company's indirect costs such as electricity, heating and marketing are distributed proportionally in relation to the activity's direct costs. This is unsatisfactory because two activities that consume the same amount of direct costs may easily consume vastly different amounts of indirect costs.

A mass-produced item may consume the same amount of man-hours and materials as a custom-made item. But the custom-made product consumes far more of e.g. the time of the company's engineers (an indirect cost) than a mass-produced item does.

This difference is not evident with traditional budgeting systems. Why a company that manufactures more and more custom products (and bases its pricing on historical costs) will quickly discover large losses. As technology makes it easier for companies to custom manufacture products, the importance of properly allocating overhead becomes more important.

It is not a simple task to introduce ABC. First, all activities must be broken down into separate components. Procurement activities can e.g. divided into negotiations with suppliers, updating the database, issuing purchase orders and handling complaints. Which activities are identified depends on the individual organisation.

According to Per Nikolaj Bukh and Lars G. Dietrichson can it e.g. look like this for a personnel department in a utility company that deals with both district heating and renovation.:

ABC became popular in the 1980s mainly due to a growing dissatisfaction with the traditional way of allocating costs. However, after a strong start, the method fell out of favour. Even Robert Kaplan, considered by some to be the father of the method, has been admitted by ABC to limping through the 1990s. A large part of the reason for the problems lay in transferring the theory to practice. Moreover, there were many companies that were not ready to say goodbye to their traditional system in favor of ABC.

This was also the reason why Kaplan published a new book in 2007 that tries to make ABC easier. TDABC (Time-driven Activity-based Costing), which he calls the new method, does this by relating the cost measurement to time spent. As Kaplan said, there are only two questions to be answered with TDABC:

• What is the cost per unit hour to provide resources for each business process?
• How long does it take to do the work required by the company's products, transactions and customers?

Despite the difficulties in implementing ABC, the method has many supporters. According to The Economist, Chrysler, the American car manufacturer, claims that it has saved hundreds of millions by introducing the system.

ABC consists of the following steps

To implement ABC, there are a number of steps the company must go through. Accountingexplained.com mentions these seven:

• Identification of the activities involved in the production process.
• Classification of each activity in relation to the cost hierarchy (ie into unit level, batch level, product level and site level).
• Identification and collection of total costs for each activity.
• Identification of the most accurate cost driver for each activity.
• Calculation of the total number of units for the cost driver relevant to each activity.
• Calculation of the activity rate. That is the cost of each activity per unit for its relevant cost driver.
• Applying each cost for each activity to products based on the activity's use of the product.