amac.9. activity based costing

What is the main idea of Activity-Based Costing (ABC)?

Overheads are grouped into activities (cost pools) and absorbed into products based on actual usage of cost drivers.

What are the main benefits of ABC?

• Better cost control
• Better pricing decisions
• Better profitability analysis

What are criticisms of ABC?

• Time consuming
• Costly
• Some arbitrary apportionment may still exist
• Limited benefit if products have similar cost structures

How does traditional absorption costing absorb overheads?

Using one OAR based on labour or machine hours.

Why is ABC more realistic in modern manufacturing?

Because fixed overheads and multiple activities drive costs, not just labour hours.

Give examples of activities used in ABC.

• Material receipts
• Material requisitions
• Repairs & maintenance
• Machine set-up
• Quality control checks

What does ABC match overheads to?

Individual activities.

Why does ABC use multiple OARs?

Because different activities drive different overhead costs.

What is a cost pool?

A breakdown of total overheads into categories depending on the activity that generated the cost.

What is a cost driver?

A factor that drives a change in the usage of an activity.

What are the steps to calculate cost per unit under ABC?

(a) Group overheads into cost pools
(b) Identify cost drivers
(c) Calculate an OAR per cost driver
(d) Absorb activity costs based on usage
(e) Calculate total activity cost per unit

Formula for OAR per cost driver?

OAR = Total cost pool ÷ Total number of cost drivers.

How does ABC improve decision making?

It provides a more realistic estimate of product costs and profits.

How does ABC improve cost control?

It identifies how overheads are incurred, allowing managers to target improvements.

How does ABC improve pricing decisions?

It shows the true cost of products, allowing better pricing structures.

How does ABC help with diversity of overheads?

It recognises different activities used by different products rather than assuming volume drives cost.

Why is ABC considered time consuming?

It requires breaking down overheads and analysing multiple cost drivers.

Why is ABC costly to implement?

It requires new systems and staff time to analyse and track cost drivers.

Why may ABC be less useful for standardised products?

Products consume similar overhead → ABC provides little additional insight.

What is a limitation related to cost drivers?

Hard to match cost pools to cost drivers in complex environments.

When is ABC most suitable?

• Overheads are high relative to prime costs
• There is a diverse product range
• There are considerable differences in resource usage
• Consumption of resources is not driven by volume