Cost and Management Accounting · Activity Based Costing

Steps and Process of Implementing Activity Based Costing (ABC)

Updated 4 October 2026 · Fact-checked

Activity Based Costing assigns overheads to products in proportion to the activities they use. You identify activities, group their costs into cost pools, choose a cost driver for each pool, compute a rate per driver unit, then multiply the rate by each product's driver usage.

Understand Steps and Process of Implementing ABC

Traditional costing spreads overheads using one base, such as direct labour hours. This can distort product cost when products use support activities in very different amounts. ABC fixes this by tracing overheads to the activities that cause them, and then to products.

The process runs in stages. First, list the main activities in the business, such as machine setup, material handling, inspection and order processing. Second, collect the overhead cost of each activity and place it in a cost pool. Activities that share the same driver can be combined into one pool.

Third, pick a cost driver for each pool. A cost driver is the factor that causes the cost of the activity to change. Setup cost is driven by number of setups. Inspection cost is driven by number of inspections. Fourth, work out the cost driver rate by dividing the pool cost by the total driver units.

Finally, assign cost to each product. Multiply each rate by the driver units the product consumes. Add the results to get overhead per product, then add direct costs. Divide by units produced to get cost per unit.

The logic is simple: products consume activities, and activities consume resources. Cost follows consumption, not volume.

Key rules to remember

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.

How to solve Steps and Process of Implementing ABC questions

Use this order for any ABC question. It matches the stages ICAI-style answers follow, so the marker can see each step.

1List the activities and the overhead cost given for each. If costs are given by nature, such as rent or power, first assign them to activities as the question directs.
2Form cost pools. Combine activities that use the same cost driver; keep others separate.
3Write the cost driver for each pool and find the total driver units from all products.
4Compute the cost driver rate for each pool: pool cost ÷ total driver units.
5Make a table of driver units used by each product, then multiply by the rate to get overhead per pool per product.
6Add the pool overheads for each product. Add direct material and direct labour to get total cost.
7Divide by units produced for cost per unit. If asked, compare with the traditional cost or find profit.
8Check that the total overhead assigned to all products equals the total overhead given.

Quickest way: Rate table and usage grid

When to use it: Use this for 5 to 10 mark numericals and for MCQs asking for a rate or the overhead assigned to a product.

For MCQs, do only the rate: pool cost ÷ total driver units. Then multiply by the usage asked for. Skip other pools.
Watch the units. Total driver units must include every product, not only the one in the question.
In written answers, draw one table: rows are pools, columns are cost, driver, total units, rate. Draw a second table for product usage and assigned cost.
Cross-check that the product overheads add up to total overhead. This catches most slips in seconds.
Write a one-line heading for each step so you earn step marks even if one figure is wrong.

Common mistakes in Steps and Process of Implementing ABC

Dividing pool cost by the units of one product instead of total driver units
Students focus on the product named in the question and forget the rate is a firm-wide figure.
Fix: Always add driver units of all products first. Write the total before dividing.
Using production units as the driver for every pool
It feels familiar from traditional absorption costing.
Fix: Pick the driver that causes the cost: setups, orders, inspections, material movements. Use machine hours only where the cost depends on them.
Not checking that total assigned overhead equals total overhead
Students rush to the final cost per unit.
Fix: Add the overhead assigned to all products and compare with the given total. A mismatch means an arithmetic or usage error.
Treating direct costs as part of cost pools
All costs are listed together in the question.
Fix: Pools hold overheads only. Add direct material and direct labour separately at the end.
Mixing batch-level and unit-level driver data
Questions give per-batch data, such as setups per batch, and per-unit data together.
Fix: Convert everything to total usage for the product: for example, setups per batch × number of batches.
Dividing total cost by the wrong number of units for cost per unit
Units produced and units sold both appear in the question.
Fix: Use units produced for cost per unit. Use units sold only when finding cost of sales or profit.

Worked examples

Example 1

A company makes products X and Y. Overheads for the period: machine setup ₹1,20,000, material handling ₹90,000, inspection ₹60,000. Cost drivers and usage: setups (X: 10, Y: 30), material movements (X: 50, Y: 100), inspections (X: 20, Y: 40). Find the overhead assigned to each product using ABC.

Show the solution

Total setups = 10 + 30 = 40. Setup rate = ₹1,20,000 ÷ 40 = ₹3,000 per setup.
Total movements = 50 + 100 = 150. Handling rate = ₹90,000 ÷ 150 = ₹600 per movement.
Total inspections = 20 + 40 = 60. Inspection rate = ₹60,000 ÷ 60 = ₹1,000 per inspection.
Product X: setups 10 × 3,000 = ₹30,000; handling 50 × 600 = ₹30,000; inspection 20 × 1,000 = ₹20,000. Total = ₹80,000.
Product Y: setups 30 × 3,000 = ₹90,000; handling 100 × 600 = ₹60,000; inspection 40 × 1,000 = ₹40,000. Total = ₹1,90,000.
Check: 80,000 + 1,90,000 = ₹2,70,000, which equals 1,20,000 + 90,000 + 60,000.

Answer: Overhead assigned: Product X ₹80,000 and Product Y ₹1,90,000.

Example 2

Using a similar set-up, a firm produces 2,000 units of Product P and 8,000 units of Product Q. Direct cost per unit: P ₹150, Q ₹100. Overheads: order processing ₹1,50,000 (driver: purchase orders; P: 100, Q: 200) and quality control ₹90,000 (driver: inspections; P: 40, Q: 50). Find the total cost per unit of each product under ABC.

Show the solution

Order processing rate = ₹1,50,000 ÷ (100 + 200) = ₹500 per order.
Quality control rate = ₹90,000 ÷ (40 + 50) = ₹1,000 per inspection.
Product P overhead = 100 × 500 + 40 × 1,000 = 50,000 + 40,000 = ₹90,000.
Product Q overhead = 200 × 500 + 50 × 1,000 = 1,00,000 + 50,000 = ₹1,50,000.
Check: 90,000 + 1,50,000 = ₹2,40,000 = 1,50,000 + 90,000.
Overhead per unit: P = 90,000 ÷ 2,000 = ₹45. Q = 1,50,000 ÷ 8,000 = ₹18.75.
Total cost per unit: P = 150 + 45 = ₹195. Q = 100 + 18.75 = ₹118.75.

Answer: Cost per unit: Product P ₹195 and Product Q ₹118.75.

Exam tips

Show the rate calculation as a separate table. Markers award marks for the rate even if the final figure is wrong.
Name the cost driver explicitly for each pool. Questions often ask you to identify it, and a missing driver loses marks.
If the question asks to compare with traditional costing, compute both and comment in one or two lines on which product was over- or under-costed.
In theory questions, list the stages in order: identify activities, form cost pools, find cost drivers, compute rates, assign to products. Add one line on each.
For MCQs, do not reason about theory. Find the rate and multiply by usage; there is no negative marking, so always attempt.

Practice questions from Activity Based Costing

Steps and Process of Implementing ABC in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Steps and Process of Implementing ABC: frequently asked questions

What are the steps in activity based costing?

Identify the activities, assign overheads to cost pools, select a cost driver for each pool, compute the cost driver rate, and assign overheads to products using their driver usage. Then add direct costs to get total product cost.

How do you calculate the cost driver rate in ABC?

Divide the total cost of a cost pool by the total number of driver units for that pool across all products. For example, ₹1,20,000 of setup cost and 40 setups gives ₹3,000 per setup.

What is a cost pool in ABC?

A cost pool is a group of overhead costs related to one activity or to activities that share a cost driver. Each pool gets its own cost driver rate.

How is ABC different from traditional costing in the process?

Traditional costing uses one or a few volume-based rates, such as labour hours. ABC uses several rates, one for each activity pool, so products that use more support activities carry more overhead.