Goal of ABC: to establish a better cause-effect relationship between products and overhead costs
Traditional Costing:
§ Costs are divvied up based on the allocation base, e.g. Direct Labor Hours
§ Cost pools are typically departments, e.g. R&D, marketing, sales, finance, human resources
§ Divide cost pool by allocation base gives the allocation rate
§ Homogeneity of cost pool is not very strong
ABC Costing:
§ Costs are divvied up based cost drivers, e.g. number of customers, machine hours, etc
§ Cost pools are typically activities, e.g. design products, set up molding machine, distribute, etc
§ Divide cost pool by the cost driver gives the allocation rate
§ Homogeneity of cost pool is strong
Cost hierarchy:
§ Unit – costs that change with the level of units produced
§ Batch – costs that change with the number of batches produced
§ Product – costs that change with the number of products supplied
§ Facility – costs that do not change much with the change in volume
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