ACCA Applied Skills · Performance Management
Activity-Based Costing for ACCA Performance Management
Activity-based costing (ABC) assigns overheads to products using the activities that cause those costs, not a single volume measure such as labour hours. You group overheads into cost pools, choose a cost driver for each, calculate a rate per driver, then multiply by each product's driver usage.
What this chapter covers
Activity-based costing is a way of sharing overheads between products. Traditional absorption costing uses one rate, usually per labour hour or machine hour. ABC replaces that with several rates, each linked to an activity such as machine set-ups, purchase orders or quality inspections.
The chapter has a clear sequence. First you see why a single volume-based rate can distort product costs. Then you learn the vocabulary: activities, cost pools and cost drivers. Then you do the calculation. Finally you judge when ABC is worth using and when it is not.
ABC connects to the rest of Performance Management in several ways. It sits beside other costing methods such as marginal and absorption costing. It feeds pricing and product mix decisions, because a distorted cost gives a distorted margin. It also links to cost management ideas and to performance measurement, where understanding what drives cost helps you control it. In the exam it can appear as a calculation in Section C, or as objective questions on drivers, pools and the pros and cons.
ABC is a classic Performance Management topic because it tests both numbers and judgement. In the objective sections you can be asked to pick a cost driver, spot a correct rate or identify a limitation. In a constructed-response question you may need to calculate ABC unit costs, compare them with absorption costing results and explain why they differ. Those are marks you can secure with a fixed method. The discussion part rewards students who tie their points to the scenario instead of listing generic advantages. Good practice here also makes later chapters on pricing and decision-making easier.
Activity-based costing: topics in the order to study them
- 1Limitations of Traditional Absorption CostingStart here to understand the problem ABC solves; it explains why a single volume-based rate can mis-cost low-volume, complex products.
- 2Cost Drivers and Cost Pools in ABCYou need the vocabulary and the logic of choosing a driver before you can build any rates.
- 3Calculating Product Costs Using ABCThis is the core calculation. It builds on pools and drivers, so learn it third and practise it most.
- 4Merits, Demerits and Uses of ABCStudy this last so your evaluation points are backed by the numbers you have just worked with.
How to prepare Activity-based costing
Treat this chapter as one method plus one discussion. Get the method automatic, then learn to comment on the results.
- Read about absorption costing first and write in your own words why one overhead rate can over-cost high-volume products and under-cost low-volume ones.
- List common activities and their drivers, such as set-ups with number of set-ups, ordering with number of purchase orders, and inspection with number of inspections. Check that each driver really causes the cost.
- Practise the calculation in four fixed steps: group overheads into pools, choose a driver for each pool, divide pool cost by total driver volume to get a rate, then multiply the rate by each product's driver usage.
- Finish every calculation by converting to a cost per unit. Divide total overhead for the product by the units made, then add direct costs if the question asks for full cost.
- Do the same question under traditional absorption costing and compare the unit costs. Write one sentence on which products gain or lose cost under ABC and why.
- Practise short written answers on merits, demerits and suitable uses. Always link each point to the scenario, such as diverse products or high overheads.
- Finish with mixed objective questions on drivers, pools and limitations, then one timed constructed-response question.
Common mistakes in Activity-based costing
Choosing a driver that does not actually cause the cost
Fix: Ask what makes the cost rise. Pick the driver with a clear cause-and-effect link, such as number of set-ups for set-up costs.
Dividing the pool by the wrong total
Fix: Add up driver usage for every product first. Divide each pool cost by that total, not by output.
Stopping at total overhead and not giving a unit cost
Fix: Re-read the requirement and divide by units made. Add direct costs only if full cost is asked for.
Giving generic merits and demerits
Fix: Pick points that fit the case, such as many products with different complexity, and explain the effect on cost and decisions.
Assuming ABC always gives a better answer
Fix: State that ABC is more useful when overheads are large and not volume-driven. Mention cost of implementation and data quality as limits.
Mixing up pools and drivers
Fix: Remember: the pool is the money, the driver is the measure of activity. The rate is money per unit of activity.
Last-day revision: Activity-based costing
- 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.
Activity-based costing practice questions
- Setup costs at Delta Co total $120,000 for the period, and the cost driver is the number of machine setups. There were 400 setups in total. …
- Kiln Co makes products P and Q. Overheads are: material handling $92,000 (driver: production batches) and inspection $70,000 (driver: inspec…
- Kora Co absorbs overheads using machine hours. Product X uses 2 machine hours per unit and Product Y uses 1 hour per unit. The overhead rate…
- Compared with a traditional absorption costing system that uses a single direct labour hour rate, what is the usual effect of switching to a…
- Bell Co makes products X and Y. Overheads are: machining $90,000 (driver: machine hours) and setups $60,000 (driver: number of setups). Tota…
- Which of the following is a typical reason for grouping several activities into a single cost pool in an ABC system?
- Which of the following is a recognised criticism of traditional volume-based absorption costing?
- Rowan Co's order processing cost pool is $48,000 and the cost driver is the number of customer orders, of which there were 1,200 in the peri…
Activity-based costing in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Activity-based costing: frequently asked questions
How do I calculate product cost using activity-based costing?
Group overheads into cost pools, pick a cost driver for each, and divide each pool by its total driver volume to get a rate. Multiply each rate by the product's driver usage and add the results. Divide by units to get overhead per unit.
What is the difference between a cost pool and a cost driver?
A cost pool is the total overhead cost for an activity. A cost driver is the measure that causes that cost to change, such as number of orders. Dividing the pool by the driver volume gives the rate.
Why does ABC give different product costs from absorption costing?
Absorption costing spreads overheads using one volume-based rate. ABC links overheads to the activities each product uses. Products that use more complex activities per unit get more cost under ABC, even if they have low volume.
Is ABC tested in the objective sections or the written section?
It can appear in both. Objective questions may test drivers, rates or limitations. A constructed-response question may ask for ABC calculations and a discussion of the results, so prepare for both.