Activity based costing allows businesses to allocate overhead costs to products in a more logical approach than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first allocates costs to the activities that are the real cause of the overhead. It then allocates the cost of those activities only to the products that are actually demanding the activities.
For Example, the higher value items have lower safety standards, because of cost of production are high in higher value items. Lower items carry higher safety standards. This method help businesses to divide inventory into three category A, B and C. In category “A” important class of inventories constitute, in category “B” mediocre inventories and in category “C” negligible importance of inventories constitute.