Cost Behaviour and Activity-Based Costing
What this domain tests
Cost behaviour underpins break-even analysis and flexible budgeting; ABC explains how overhead is actually consumed. The exam tests classification of costs, the relevant range, the design of ABC systems and the critique of ABC.
Core rules
- Fixed costs are constant in total within the relevant range; variable costs are constant per unit; semi-variable costs contain both elements; step costs jump at capacity thresholds.
- ABC is a two-stage process: resources are assigned to activity cost pools, then pools are assigned to products using cost drivers.
- The activity hierarchy: unit-level (machine hours), batch-level (set-ups, inspections), product-level (design, engineering change) and facility-level (factory rent, security). Facility-level costs are generally not attributable to products.
- ABC suits organisations with diverse products, high overhead, low direct labour and varied batch sizes.
- Activity-based management uses ABC data to eliminate non-value-added activities.
Worked example
Total overhead Rs. 900,000: a set-up pool of Rs. 300,000 for 500 set-ups (Rs. 600 each) and a machining pool of Rs. 600,000 for 30,000 machine hours (Rs. 20 each). Product A: 200 set-ups and 8,000 machine hours = 120,000 + 160,000 = Rs. 280,000. Product B: 300 set-ups and 22,000 machine hours = 180,000 + 440,000 = Rs. 620,000. Under a single machine-hour rate of Rs. 30, A would absorb Rs. 240,000 and B Rs. 660,000. ABC shows A is more expensive than the plant-wide rate suggests because it consumes disproportionate set-ups relative to machine hours - the classic low-volume, high-complexity distortion.
Traps
Using a single plant-wide rate and assuming it is correct; treating facility-level costs as product-level; choosing a driver that is not causal (for example direct labour hours in a highly automated plant); forgetting that ABC is more accurate but costly to maintain, and can be replaced by time-driven ABC.