Activity Based Costing

Activity-based Cost Management: An Executive's GuideGoal 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