Management Accounting
Activity Based Costing
ABC questions require you to identify cost drivers, apportion and allocate overheads using activity-based rates, calculate unit costs and selling prices, and compare ABC with traditional absorption costing methods.
Show the cost driver rate calculation clearly: Total cost pool ÷ Total cost driver units. When comparing ABC with traditional absorption costing, always explain why the costs differ and discuss the advantages and limitations of each method.
Key Concepts to Revise
What is ABC?
Activity Based Costing allocates overheads to products based on the activities that cause costs (cost drivers), rather than on volume-based bases like labour hours.
Cost Drivers
Definition: The factor that causes a cost pool to increase — e.g. number of set-ups, machine hours, purchase orders
Rate: Cost pool total ÷ Total cost driver units
Apportioning Overheads
Step 1: Group overheads into cost pools by activity
Step 2: Multiply cost driver rate × units of driver consumed per product
Unit Cost & Selling Price
Total cost: Direct materials + Direct labour + ABC overhead per unit
Selling price: Total unit cost + required profit margin
ABC vs Traditional
Traditional: Single overhead absorption rate — simple but can distort costs for diverse products
ABC: More accurate for complex operations — but costly and time-consuming to implement
Uses & Limitations
Uses: Pricing decisions, identifying unprofitable products, performance management
Limitations: Complex to set up, requires judgement in identifying cost pools and drivers