CB2101 Chap.5 Activity Based Costing
Activity Based Costing
Assign overhead through activities
Activity-based costing first assigns resource cost to activity pools and then assigns those pools to cost objects using drivers. It is most useful when products differ in complexity and consume batch, product or customer activities in different proportions.
More pools help only when their drivers represent real resource consumption.
Diagnose the broad average
A plantwide volume base can shift cost toward high-volume simple products and away from low-volume complex products. The distortion appears when support work follows setups, orders, moves or inspections rather than units. Compare activity consumption shares with traditional allocation shares.
A large mismatch indicates cross-subsidy, but the cause must be traced to work performed rather than assumed from product labels.
Build two stages deliberately
First-stage assignment moves resource costs into activity pools using evidence about how resources support the activities. Second-stage assignment multiplies each activity rate by a cost object's driver use. Keep the stages visible.
A product cannot consume salaries or rent directly in the model; it consumes setups, handling or another defined activity that draws on those resources.
Choose drivers for causality
A convenient measure is not automatically a driver. Setup count should represent setup work, material moves should represent handling and order count should represent procurement effort.
Test data reliability, but also ask whether a change in the driver would reasonably change resource demand. If not, the rate adds detail without adding explanation.
Respect the activity level
Unit-level work follows each unit, batch-level work follows groups of units, product-sustaining work supports a line, and facility-sustaining work supports the organisation.
Dividing batch cost by units can be useful for reporting, but it does not make units the cause. Return to the activity level before forecasting savings or deciding whether volume changes the resource commitment.
Move from costing to management
ABC reallocates cost; activity-based management changes work.
A product cost reduction becomes real only when setups, moves, inspections or another avoidable activity is reduced and the underlying resource commitment changes. Implementation also has a cost. Add pools where better information can change pricing, design, process or customer decisions, and resist complexity that has no decision payoff.
What this chapter covers
- 01
Activity cost pools
- 02
Cost driver selection
- 03
First-stage resource assignment
- 04
Second-stage object assignment
- 05
Product cross-subsidy
- 06
Activity-based management
Worked example · free
Assign setup cost with an activity rate
- 2Compute the activity rate.
- 2Assign pool cost.
- 2Find assigned cost per unit.
Key terms
- Activity Pool
- A grouping of overhead resources associated with one kind of work.
- Cost Driver
- A measure used to represent a cost object's consumption of an activity.
- Cross-subsidy
- A distortion in which one cost object receives cost caused by another.
Activity Based Costing FAQ
Why can a volume-based rate distort product cost?
A low-volume complex product may cause many setups, orders or inspections while a high-volume simple product causes few. Assigning support cost by units shifts cost toward volume instead of the activities that consumed resources.
Does ABC automatically reduce costs?
No. ABC reallocates reported cost and reveals costly activities. Savings require activity-based management that removes unnecessary work, redesigns a process or changes demand for the activity.
When might ABC not be worth implementing?
If products consume support activities in similar proportions or decisions would not change, the data collection and maintenance cost can exceed the benefit. Detailed pools are valuable only when better causality improves action.
How do I distinguish an activity saving from reallocation?
Reassigning a pool changes reported product costs but leaves total resources unchanged. A saving requires fewer setups, moves, inspections or other activities and a corresponding reduction or redeployment of the underlying resource commitment. State the operational action, the activity quantity expected to fall and the resource cash flow that can change. Otherwise the result is information, not savings.
Exam move
For each pool, write the activity, resource cause, driver unit, total driver quantity, rate and cost-object use. Keep first-stage resource assignment separate from second-stage object assignment. Compare a traditional unit-based allocation with the ABC result and explain the consumption pattern that creates cross-subsidy.
Sort activities into unit, batch, product-sustaining and facility-sustaining levels, then predict which costs change when units, batches or product lines change. Challenge every convenient data field by asking whether a change in the measure would plausibly change resource demand. Finish with an activity-based management response that removes work or changes a resource commitment, rather than calling a reallocation a saving.
Note when implementation effort would exceed the decision benefit.
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