1. Management accounting
Activity based costing
Summary
Learning outcome
Compare and contrast activity based costing with traditional marginal and absorption costing
methods.
What you must know
 Definition of activity-based costing.
 Appropriateness of traditional versus activity-based costing for decision-making and
performance evaluation purposes.
 Conditions under which ABC system analysis differs from traditional system analysis.
 Steps in the basic ABC process.
 Allocating costs to products using ABC analysis.
 The benefits and problems of ABC.
Unit synopsis
 Activity-based costing (ABC) is an approach to the costing and monitoring of activities
which involves tracing resource consumption and costing final outputs. Resources are
assigned to activities and activities to cost objects based on consumption estimates. The
latter utilize cost drivers to attach activity costs to outputs.
 Traditional cost accounting involves attributing indirect costs to individual products on
the basis of an overhead absorption base related to some proxy. This approach provides
ambiguous results in modern circumstances.
 The conditions under which ABC system analysis differs from traditional system analysis
are:
o When production overheads are high relative to direct costs, particularly direct
labor.
o Where there is great diversity in the product range.
o Where there is considerable diversity of overhead resource input to products.
o When consumption of overhead resources is not driven primarily by volume.
 The different steps to a basic ABC process are:
o Step 1: Identify the main production-related activities of the organization.
o Step 2: Identify the cost (cost pool) of each of the activities identified in Step 1.
o Step 3: Determine the cost driver for each activity identified in Step 1.
o Step 3a: Select the activity cost pools and cost drivers that will be used within the
system.
o Step 4: Calculate a cost driver rate for each activity cost pool in the same way as
an overhead rate is calculated in a traditional system.
o Step 5: Apply the activity cost driver rates to products (cost units) to arrive at an
activity-based product cost.

2.  The hierarchy of cost comprises the following activities:
o Unit-level.
o Batch-level.
o Product-level.
o Facility-level.
 The formula for calculating cost driver rates:
Cost driver rate =
Activity cost pool
Activity driver
NobleKasonde Bwembya2016.