CMA Intermediate · Management Accounting

Activity Based Costing: formula sheet

Full chapter guide

Key formulas

Traditional overhead absorption rate (OAR): OAR = Total overheads ÷ Total base (labour hours, machine hours or other volume measure); One rate for all products. Overhead charged to a product = OAR × the product's base units.
ABC cost driver rate: Cost driver rate = Cost of the activity pool ÷ Total quantity of the cost driver; Calculated for each activity pool, for example cost per set-up or cost per inspection.
ABC overhead charged to a product: Overhead = Σ (Cost driver rate × Driver units used by the product); Add across all activity pools. Divide by units produced for overhead per unit.
Direction of distortion: Under-costed: ABC cost > traditional cost. Over-costed: ABC cost < traditional cost; Treat ABC as the more accurate figure when you compare. The gap shows the distortion.
Cost driver rate (activity driver rate): Cost driver rate = Total cost of the activity cost pool ÷ Total quantity of the cost driver; For example, ₹ per set-up or ₹ per inspection. This is the rate used to charge products.
Overhead assigned to a product: Overhead for a product = Cost driver rate × Quantity of the driver used by that product; Do this for each cost pool and add the results. Divide by units produced for overhead per unit.
Two-stage ABC flow: Resources → (resource drivers) → Activity cost pools → (activity drivers) → Products; Use this to answer questions on the difference between resource drivers and activity drivers.
Cost hierarchy: Unit level, Batch level, Product level, Facility level; Ordered from most volume-related to least. Facility level costs are usually not traced to products.
Cost driver rate: Cost driver rate = Total cost of the activity pool ÷ Total quantity of the cost driver; Use the total driver units for all products in the period, not for one product.
Overhead assigned to a product: Overhead assigned = Cost driver rate × Driver units consumed by the product; Do this for every pool, then add the amounts.
Overhead per unit: Overhead per unit = Total overhead assigned to the product ÷ Units produced; Use units produced or units of the batch costed, as the question requires.
Total product cost: Total cost = Direct material + Direct labour + Other direct costs + ABC overheads; Selling price or profit comparison needs this full cost.
Check on allocation: Σ overhead assigned to all products = Total overhead of all pools; If it does not tie, a driver total or a rate is wrong.
Cost driver rate: Cost driver rate = Cost of activity pool ÷ Total cost driver units; Use the total driver units of all products, not of one product.
Overhead charged to a product: Overhead to product = Σ (Cost driver rate × Driver units used by the product); Do this pool by pool, then add.
Overhead per unit under ABC: Overhead per unit = Total overhead charged to product ÷ Units produced; Divide by units produced, not by driver units.
Traditional overhead rate: Rate = Total overhead ÷ Total base (direct labour hours or machine hours); One single rate for all overheads.
Total cost and profit: Total cost = Prime cost + Overhead; Profit = Sales − Total cost; Total profit of the firm is the same under both methods if all overhead is absorbed.
Cost difference: Difference = ABC cost − Traditional cost; Positive means traditional costing undercosts the product.
Cost driver rate: Cost driver rate = Total cost of the activity pool ÷ Total volume of the cost driver; Used to apply overheads to products in ABC, which ABM then analyses.
Cost of an activity for a product: Activity cost = Cost driver rate × Driver units used by the product; Use this to find how much NVA cost a product carries.
NVA cost share: NVA cost % = (Cost of NVA activities ÷ Total activity cost) × 100; A simple measure of the improvement potential under ABM.
Value-added test: Activity is VA only if it (a) changes the product or service, (b) the customer wants the change, and (c) it is done right the first time; If any condition fails, treat the activity as NVA.

Quick revision

ABC charges overheads on activities consumed, not just on volume.
Traditional costing uses one or few volume-based rates, which can over-cost high-volume products and under-cost complex low-volume ones.
A cost driver is the factor that causes the cost of an activity to change.
A cost pool groups the costs of one activity or related activities.
Cost driver rate = cost pool ÷ total quantity of the cost driver.
Overhead assigned to a product = cost driver rate × driver units used by that product.
Unit cost = (direct cost + assigned overhead) ÷ units produced.
Cost hierarchy levels: unit, batch, product-sustaining and facility-sustaining.
Facility-level costs are hard to link to drivers and are often allocated arbitrarily.
Activity Based Management uses ABC information to cut non-value-adding activities and improve decisions.
Always compare ABC with traditional cost and comment on the difference.
ABC can be costly and complex to install, and drivers may be hard to measure.

Common mistakes

Saying traditional costing is wrong because it uses overhead absorption at all. Fix: Say the flaw is the single volume-based rate that ignores the real cost drivers. ABC also absorbs all overheads; it does so on a better basis.
Reversing under-costing and over-costing. Fix: Remember: complex low-volume products are under-costed by traditional costing, and simple high-volume products are over-costed. Check by comparing the two unit costs.
Treating resource drivers and activity drivers as the same thing. Fix: Remember the stages. Resource driver: resources to activities. Activity driver: activities to products.
Classifying set-up cost as unit level because it is a production cost. Fix: Set-up happens once per batch, so it is batch level. Test whether cost changes with units or with batches.
Dividing the pool cost by the driver units of only one product Fix: Always total the driver units across every product before computing the rate.
Choosing a volume-based driver for every activity Fix: Match the driver to the cause: set-ups for set-up cost, inspections for inspection cost, orders for order processing.
Dividing the pool cost by the driver units of one product instead of all products. Fix: Always write the total driver units first. The rate is pool cost ÷ total of all products.
Dividing ABC overhead by driver units instead of units produced to get per-unit cost. Fix: Per-unit cost always uses the number of finished units produced or sold, as asked.
Treating all inspection and quality activities as value-added. Fix: Inspection only checks work and does not change the product. Treat it as NVA, even if necessary in practice. Prevention activities that build quality in are better regarded as supporting improvement.
Confusing ABC with ABM. Fix: ABC is a costing method that assigns overheads. ABM is a management approach that uses ABC data to improve activities and decisions.

Exam tips

In theory answers, use the sequence flaw, distortion, decision effect, ABC remedy. It covers the points examiners look for.
In numerical comparisons, always add up both methods' total overheads and show they match. It protects you from calculation slips and earns marks.
State clearly which product is under-costed and which is over-costed, and give the rupee difference per unit.
For MCQs, remember the key words: single volume-based rate, cross-subsidisation, cost drivers. Options that say ABC reduces total overhead are wrong.
Do not call ABC perfect. Mention that it needs more data and effort, which is covered in its limitations.
In theory questions, define each term in one line and give an example. Examples earn marks that bare definitions do not.
Always state the stage when you mention a driver: resource driver for stage one, activity driver for stage two.
Write the cost hierarchy as a short list of four levels with an example against each. It is a common short-note question.