ACCA Applied Skills · Performance Management

Activity-based costing: formula sheet

Full chapter guide

Key formulas

Traditional absorption rate: Absorption rate = Budgeted overhead for the cost centre ÷ Budgeted activity (e.g. direct labour hours); One volume-based rate per centre. It assumes overhead varies with the chosen volume measure.
Overhead charged to a product (TAC): Overhead per unit = Absorption rate × Hours per unit; Every unit with the same hours gets the same overhead, whatever its complexity.
ABC cost driver rate: Rate per driver = Cost pool ÷ Total cost driver units; Used to compare with TAC. Products are charged by the activities they actually use.
Direction of distortion: TAC cost < ABC cost → product undercosted; TAC cost > ABC cost → product overcosted; Usually low-volume, complex products are undercosted and high-volume, simple products are overcosted.
Cost per unit of cost driver: Cost per driver unit = Total cost in the pool ÷ Total volume of the cost driver; Use the total driver volume for all products in the period, not for one product.
Overhead absorbed by a product: Overhead charged to product = Cost per driver unit × Driver units used by the product; Repeat for every pool and add the results. Divide by units produced for a unit cost.
Choosing a driver (rule): Good driver = causal link to cost + measurable + data available at reasonable cost; If two drivers fit, choose the one with the stronger cause-and-effect link.
Cost hierarchy: Unit-level → Batch-level → Product-level → Facility-level; Match the driver to the level: units, batches, products or no real driver.
Activity absorption rate: Activity rate = Cost pool ÷ Total cost driver volume; Use the total driver volume for all products, not for one product.
Overhead charged to a product: Overhead for product = Σ (activity rate × driver units used by the product); Add the charge from every activity pool.
ABC overhead per unit: Overhead per unit = Total overhead charged to product ÷ Units produced; Divide by units of that product, not total units.
Full ABC unit cost: Unit cost = Direct materials + Direct labour + ABC overhead per unit; Direct costs are traced as normal in both methods.
Traditional absorption rate: Rate = Total overheads ÷ Total absorption base (e.g. machine hours); Used as the comparison. Total overhead absorbed must equal total under ABC.
Cost driver rate: Cost per driver unit = Total cost of the activity pool ÷ Total number of driver units; Use the expected level of the driver for the period, for example set-ups or inspections.
Overhead charged to a product under ABC: Overhead = Σ (cost driver rate × driver units used by the product); Add the charge from each pool, then divide by units produced for cost per unit.
Cost hierarchy: Unit-level, batch-level, product-level, facility-level; Facility-level costs have no sensible driver, so they are often absorbed on a volume basis or left out of unit cost.

Quick revision

ABC assigns overheads according to the activities that cause them.
Traditional absorption costing usually uses one volume-based rate, such as per labour hour.
Single-rate absorption can distort costs when overheads are not driven by volume.
A cost pool is a group of overhead costs linked to the same activity.
A cost driver is the factor that causes the cost of an activity to change.
ABC rate = cost of the pool ÷ total quantity of the cost driver.
Product overhead = ABC rate × the product's use of the driver, summed over all pools.
Unit overhead = total overhead for the product ÷ units produced.
ABC tends to raise the cost of low-volume, complex products relative to absorption costing.
ABC suits firms with high overheads, diverse products and varied activity demands.
ABC can be costly and time-consuming to set up, and some allocations remain arbitrary.
ABC is not a magic fix; it needs accurate data on drivers and costs.

Common mistakes

Saying TAC is wrong because it uses a rate at all. Fix: Say the problem is the single volume-based driver. ABC also absorbs overheads, but with several drivers.
Stating that low-volume products are always undercosted by TAC. Fix: Calculate it. The result depends on activity usage per unit. Say 'typically' unless the numbers prove it.
Dividing the pool cost by the driver volume of one product only. Fix: Always add the driver volumes for every product first. Then calculate one rate for the pool.
Choosing a volume-based driver, such as machine hours, for every pool. Fix: Ask what makes this cost go up. Set-ups follow batches, orders follow number of orders, inspections follow inspections.
Dividing a cost pool by one product's driver volume instead of the total volume. Fix: Always calculate the rate from total driver volume first. Then apply it to each product.
Forgetting to divide by units produced at the end. Fix: Label every figure as total or per unit. Divide the product's total overhead by its own units.
Listing advantages and disadvantages with no link to the scenario. Fix: Tie every point to a fact in the question, such as high overheads or similar products.
Saying ABC removes all arbitrary apportionment. Fix: State that facility-level costs and the choice of pools and drivers still need judgement.

Exam tips

In written parts, structure answers as cause, distortion, consequence. Three linked points score better than a list of five unexplained ones.
In numerical comparisons, show the TAC and ABC unit costs side by side and state the difference for each product.
Use the scenario facts. Mention the actual products, volumes, batch counts or overhead levels given.
In OT questions, watch for 'volume-based' and 'cross-subsidisation'. Options that claim TAC ignores overhead altogether are wrong.
Where a limitation of ABC is also asked, give a short balanced point, such as cost of data collection and arbitrary apportionment of some costs.
In OT questions, match the driver to the cost cause. Set-ups link to batches, purchasing to orders and quality checks to inspections.
Always compute the rate from total driver volume across all products, then apply it to the product asked about.
In Section C, set out one pool per row in a small calculation: pool cost, driver volume, rate, then product charge. This earns method marks even if you slip.