ACCTG 221 Chap.5 Activity-Based Costing and Management
Activity-Based Costing and Management
Activity-based costing separates overhead into pools linked to activities and assigns each pool using a driver that reflects consumption. The method does not create or remove total overhead; it changes how overhead is distributed across products, services or customers. Where complexity differs, a single volume rate can cross-subsidise outputs.
Activity-based management uses the clearer cost pattern to reduce non-value-adding work, redesign processes and test whether the information benefit justifies measurement cost.
What this chapter covers
- 01
Activity pools and resource costs
- 02
Cost drivers and driver volumes
- 03
Two-stage assignment to cost objects
- 04
Cross-subsidy under broad averages
- 05
Activity-based management and process redesign
- 06
Implementation cost and behavioural limits
Worked example · free
North Shore Cases: two activity pools
- +2Setup rate = $360,000 ÷ 120 = $3,000 per setup; dispatch rate = $560,000 ÷ 28,000 = $20 per order.
- +2Custom overhead = 90 × $3,000 + 8,000 × $20 = $430,000, or $43 per unit.
- +2Standard overhead = 30 × $3,000 + 20,000 × $20 = $490,000, or $24.50 per unit.
- +2ABC unit costs are $163 and $109.50; allocated overhead reconciles to $920,000.
Key terms
- Activity pool
- A grouping of costs associated with one activity.
- Cost driver
- A measurable factor used to assign an activity pool.
- Cross-subsidy
- Overcosting one object while undercosting another.
- Value-adding activity
- Work customers value or operations require.
- Activity management
- Using activity information to improve processes.
Activity-Based Costing and Management FAQ
Does ABC reduce total overhead?
No. Changing the assignment method redistributes the same overhead pools unless management also changes the underlying activities. Always prove that product or customer allocations add back to the total pool cost.
When is ABC most useful?
ABC is especially useful when overhead is material, outputs consume activities in very different patterns and reliable drivers can be measured. A homogeneous operation may gain little from the additional detail.
How does ABC support management action?
The pool and driver structure reveals which activities consume resources. Managers can then target non-value-adding work, change batch sizes, simplify designs or redesign processes, while comparing expected savings with implementation cost and risk.
Exam move
List activities before choosing drivers. A driver should have a credible cause-and-effect relation with the pool, not merely be easy to count. Compute one rate per pool, attach units to that rate and trace each product's measured driver use. Reconcile allocations to every pool and compare the ABC pattern with the broad-rate pattern to locate cross-subsidy.
When recommending action, separate a better cost signal from actual cash savings: reallocation alone saves nothing. Quantify the driver reduction needed, the recurring resource saving, implementation cost and payback. Discuss data quality, employee response, process disruption and whether unused capacity can actually be removed or redeployed. A precise-looking model is not automatically decision-useful.
Construct a driver dictionary for practice problems. For each pool, record the activity, cost included, driver unit, practical reason the driver changes and source of measurement. Reject a convenient driver when it has no credible relation to resource use. Calculate rates with units such as dollars per setup or dollars per order, then multiply by product consumption and reconcile every pool independently.
Compare ABC with a plant-wide rate using a two-product case where complexity differs. Describe the cross-subsidy direction and identify the activity pattern responsible; do not say merely that ABC is more accurate. Next separate assignment insight from management action. A newly revealed high cost does not disappear until the organisation changes an activity or releases or redeploys resources.
Quantify a proposed driver reduction, recurring saving, implementation cost and payback, then test whether the resource is actually avoidable. For customer or channel analysis, include order handling, delivery and support activities only when the data support those pools. In written revision, discuss maintenance burden, interview bias, changing processes and employee incentives as limits on excessive detail.
Finish each case with a conditional recommendation that names the cost signal, the operational change and the evidence needed to confirm cash savings. This prevents the cost model from being mistaken for the decision itself. Compare the decision with a simpler costing method and ask whether the different allocation would change action.
If both methods support the same price or process choice, extra data collection may have little incremental value. If the decision changes, identify which pool and driver create the difference and test that measurement most carefully before implementation. Review driver availability before promising frequent updates, because an elegant model that cannot be maintained soon becomes an unreliable basis for action.
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