Activity Based Costing (ABC) differs from Absorption Costing (AC) in the manner in which overheads are charged to units.
ABC charges overheads to units based on their proportionate consumption of the driver of each separate overhead activity
Key Terms
Cost Pool
Cost Driver & Prime Driver
Prime Driver Rates
Activity Based Costing – The Advent of ABC (Ignore Inflation)
Activity Based Costing – Steps
Identify overhead activities
Decide on prime driver of each overhead activity
Record overhead activity cost in cost pools and the number of prime drivers for each overhead activity for the period
Determine the prime driver rates
Charge overheads to units based on their proportionate consumption of the driver of each separate overhead activity.
Activity Based Costing – Arguments For
Provides a more accurate assessment of unit costs
Underpins the competitive pricing of units on a cost plus basis
Provides an improved insight into the drivers which may lead to cost reduction opportunities
Highlights the cost of overhead activities for benchmarking against best practice/industry averages etc
Helps management assess the value added proposition of internal overhead activities
Activity Based Costing – Arguments Against
Consumes increased resources to identify and record cost pools and cost driver activity
There are many factors which influence the cost of an overhead activity in addition to the prime driver
The selection of the prime driver of each activity is subjective
It is considered as simply an extension of Absorption Costing (AC)