CA Intermediate · Cost and Management Accounting

Activity Based Costing: formula sheet

Full chapter guide

Key formulas

Traditional overhead absorption rate: Rate = Total overheads ÷ Total base (labour hours, machine hours or direct wages); One rate for the plant or department. Overhead charged = Rate × base used by the product.
ABC cost driver rate: Cost driver rate = Cost of activity pool ÷ Total quantity of cost driver; Example: set-up cost ÷ number of set-ups. Different pools have different rates.
ABC overhead for a product: Overhead = Σ (Cost driver rate × Driver units used by the product); Add across all activity pools.
Distortion: Distortion = Traditional cost per unit − ABC cost per unit; Positive means the product was over-costed; negative means under-costed.
Cost driver rate: Cost driver rate = Total cost of the activity cost pool ÷ Total quantity of the cost driver; Use the total expected driver volume across all products. This is the stage-two rate.
Overhead assigned to a product: Overhead charged = Cost driver rate × Quantity of driver used by the product; Repeat for each pool and add the results. Then divide by units produced for overhead per unit.
Two-stage ABC flow: Resources → (resource drivers) → Activity cost pools → (activity drivers) → Products; Stage one assigns resource cost to activities. Stage two assigns activity cost to products.
Activity hierarchy: Unit level → Batch level → Product level → Facility level; Unit varies with units, batch varies with batches, product varies with product lines, facility does not vary with any of them.
Cost driver rate: Cost driver rate = Total cost of the cost pool ÷ Total units of the cost driver; Use the total driver units across all products for the period, not just one product.
Overhead assigned to a product from a pool: Overhead assigned = Cost driver rate × Driver units used by the product; Repeat for every pool and add the results.
Total ABC overhead of a product: Total overhead = Σ (Rate of each pool × Product's usage of that driver); Add any volume-based overhead pool, such as machine hours, in the same way.
ABC cost per unit: Cost per unit = (Direct cost + Total ABC overhead) ÷ Units produced; Check that direct cost and units refer to the same batch or period.
Cost driver rate: Cost driver rate = Cost of activity pool ÷ Total quantity of cost driver; Use the total driver quantity of all products, not of one product.
Overhead assigned to a product: Overhead of product = Σ (Driver units used by product × Driver rate of that activity); Do this activity by activity, then add.
Total cost of product: Total cost = Direct material + Direct labour + Direct expenses + ABC overheads; Direct costs are traced directly, not through activities.
ABC cost per unit: Cost per unit = Total cost of product ÷ Units produced; Use units produced or the number of units the question specifies, such as a batch.
Traditional overhead rate: Rate = Total overheads ÷ Total base (labour hours, machine hours or units); Needed for the comparison with ABC.
Profit check: Total overhead absorbed under ABC = Total overhead absorbed under traditional costing; If these differ, you have made an error.
Cost driver rate: Cost driver rate = Cost of activity cost pool ÷ Total cost driver volume; Used to assign each activity's cost to products.
Overhead assigned to a product: Overhead assigned = Cost driver rate × Driver units consumed by the product; Add across all activities to get total overhead for the product.
ABC vs ABM: ABC = costing system; ABM = management use of ABC information; Use this distinction in short notes.

Quick revision

ABC charges overheads by the activities that cause them, not by a single volume base.
Traditional costing tends to over-cost high-volume simple products and under-cost low-volume complex ones.
An activity is a task or event that consumes resources and causes cost.
A cost pool groups the costs of one activity or related activities.
A cost driver is the factor that causes the cost of an activity to change.
Rate per driver unit = Cost of the pool ÷ Total volume of the driver.
Product overhead = Σ (Driver units used by the product × Rate per driver unit).
Cost hierarchy levels: unit-level, batch-level, product-level, facility-level.
Facility-level costs are hard to link to drivers, so they are often spread on a broad base or kept separate.
Cost per unit = Total cost of the product ÷ Units produced.
ABC needs more data and effort, so it suits firms with diverse products and high overheads.
Always attempt every MCQ; there is no negative marking.

Common mistakes

Saying traditional costing ignores overheads. Fix: Write that overheads are absorbed, but on a single volume-based rate that does not reflect resource consumption.
Reversing over-costing and under-costing. Fix: High-volume products take a large share of the base, so they carry too much overhead. Low-volume complex products carry too little. Check with the totals.
Mixing up resource drivers and activity drivers. Fix: Resource driver: resources to activities. Activity driver: activities to products. Remember the order of the flow.
Classifying setup cost as unit level. Fix: A setup happens once per batch whatever the batch size, so it is batch level.
Dividing pool cost by the units of one product instead of total driver units Fix: Always add driver units of all products first. Write the total before dividing.
Using production units as the driver for every pool Fix: Pick the driver that causes the cost: setups, orders, inspections, material movements. Use machine hours only where the cost depends on them.
Dividing the pool cost by one product's driver quantity instead of the total. Fix: Always add driver units across all products first. The rate is a single figure per activity.
Applying the traditional rate on top of the ABC rates. Fix: Use either ABC or traditional overhead for a given calculation. Only direct costs are common to both.
Treating ABC and ABM as the same thing. Fix: Write that ABC is the costing method and ABM is the management approach that uses ABC data.
Writing benefits and limitations as bare headings such as 'accuracy' or 'costly'. Fix: Add one explanatory clause to each point, for example 'accuracy, because overheads follow actual resource use'.

Exam tips

For a 'differentiate' question, use a two-column format with at least five rows: basis of charging, number of rates, cost drivers, accuracy and suitability.
In numericals, show both methods side by side and end with a one-line comment on which product is over-costed or under-costed.
Check that ABC and traditional overhead totals agree before you finish.
In theory answers, link each limitation to its consequence, such as wrong pricing. This earns more than a bare list.
MCQs often test who gets over-costed under traditional costing. Answer: the high-volume, simple product.
Learn the four activity levels with one example each. Questions often give a list of activities and ask you to classify them.
In definition answers, always mention the two stages and the word cost driver. These are the words examiners look for.
In numericals, show each pool's driver rate on its own line and cross-check that total assigned overhead equals total pool cost.