Page 2 - ABC Notes

Activity Based Costing

ABC Terminology

ABC has its own language. The following are key terms used in an ABC system;

Activity: an activity is a process that uses up resources.

Examples of activities in manufacturing and service industries:

Setting up machines
Ordering materials
Quality inspections
Maintaining machines
Processing a loan application
Client meetings

Cost pool: a cost pool is similar in idea to the cost centre - it is a pool where cost data
relating to particular activity is accumulated.

Cost driver: The event and factors which cause an activity to occur and to consume
resources

Examples of activities and their associated cost drivers

Activity Cost Driver
Setting up machines Number of set-ups
Processing loan applications Number of applications
Ordering materials Number of material requisitions
Quality inspections Number of inspections
Client meetings Number of meetings

Cost driver rate: a cost driver rate is similar in idea to the overhead absorption rate. A
cost driver rate is calculated by dividing the total of the activity's cost pool by the
relevant cost driver. A cost driver rate will be calculated for every activity.

Setting up an ABC system

There are six steps involved in setting up an ABC system

1. Identify the major activities within the organisation.
2. Identify cost drivers for each activity.
3. Calculate the cost per driver.
4. Accumulate the cost per driver to product or services.
5. Calculate the overhead cost per unit.
6. Calculate the total cost per unit

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