Activity Based Costing and Activity Based Management
Domain focus
Activity based costing assigns overhead through activities and cost drivers, improving product and customer cost accuracy. Activity based management uses that information for process improvement, pricing and cost reduction.
Core rules
- ABC stages: identify activities, group costs into pools, select cost drivers, calculate driver rates, assign to products.
- A cost driver causes activity cost; a resource driver assigns resources to activities, while an activity driver assigns activities to cost objects.
- ABC is most useful where overhead is high, product diversity is wide and non-volume activities dominate.
- ABM includes activity analysis, value-added versus non-value-added assessment and driver-based improvement.
Worked example
A setup cost pool is ₹120,000 with 300 setups, giving ₹400 per setup. Product A uses 100 setups: assigned cost ₹40,000. Product B uses 200 setups: ₹80,000. If A makes 2,000 units, setup cost per unit is ₹20; B makes 5,000 units, so ₹16 per unit. A volume-based machine-hour rate would spread setup cost differently and may overcost high-volume B if B consumes fewer setups per unit. Reasoning: assign cost according to the activity consumed, not output volume alone.
Traps
Using a volume driver for a batch-level cost; dividing pool cost by total units instead of driver quantity; treating ABC as suitable for every overhead; ignoring unused capacity; calling any cost driver an activity driver.