Activity Based Costing - Essay 4

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Topic Gateway Series

Activity Based Costing

Activity Based Costing
Topic Gateway Series No. 1


Prepared by Stephanie Edwards and Technical Information Service

Revised November 2008

Topic Gateway Series

Activity Based Costing

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While using such a simplistic volume measure to allocate overheads as an overall cost driver, this approach seldom meets the cause-and-effect criteria desired in accurate cost allocation. This method of costing has become increasing inaccurate as the relative proportion of overhead costs has risen. This distortion of costs can result in inappropriate decision making. ABC is therefore an alternative approach to the traditional method or arbitrary allocation of overheads to product, services and customers.

Stage 1. Activity cost pools Material Handling

Stage 1. Activity cost pools Cost per material movement



Cost per purchase order

Product lines


Cost per set-up

Figure 1. Framework of activity based costing


Topic Gateway Series

Activity Based Costing

In contrast to traditional cost accounting systems, ABC systems first accumulate overheads for each organisational activity. They then assign the costs of these activities to products, services or customers (referred to as cost objects) causing that activity. The initial activity analysis is clearly the most difficult aspect of ABC. Activity analysis is the process of identifying appropriate output measures of activities and resources (cost drivers) and their effects on the costs of making a product or providing a service. ABC systems have the flexibility to provide special
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