Management Accounting · Activity Based Costing

Cost Driver and Cost Pool in Activity Based Costing

Updated 10 October 2026 · Fact-checked

Activity Based Costing (ABC) assigns overheads to products in two stages. First, resources are traced to activities and collected in cost pools using resource drivers. Then each pool is charged to products using an activity driver, such as number of set-ups. Activities are grouped as unit, batch, product and facility level.

Understand Concepts and Terminology of Activity Based Costing

Traditional costing spreads overheads over products using one broad base, such as direct labour hours. Activity Based Costing (ABC) starts from a different idea: products do not consume overheads directly. Products consume activities, and activities consume resources. So you cost the activities first and then charge products for the activities they use.

An activity is a task or work event that causes cost, for example machine set-up, purchase order processing, quality inspection or material handling. A cost pool is the collection of all costs related to one activity (or a group of related activities). For example, the cost pool for inspection holds inspectors' salaries, testing equipment depreciation and related costs.

A cost driver is the factor that causes the cost of an activity to change. There are two kinds. A resource driver measures how much of a resource (such as salaries, power or rent) is consumed by an activity. It is used in the first stage to assign resource costs to activity cost pools. An activity driver measures how much of an activity a product or customer uses, for example number of set-ups or number of inspections. It is used in the second stage to assign each cost pool to products.

Activities are also arranged in a cost hierarchy, based on what causes them:

Unit level: performed for every unit produced, such as machining or direct power. Cost varies with volume.
Batch level: performed for each batch, such as set-ups, batch inspection and material ordering. Cost varies with number of batches, not units.
Product (sustaining) level: performed to support a product line, such as product design, engineering changes and product testing.
Facility (business sustaining) level: supports the whole plant, such as building rent, plant security and general management. No sensible driver exists, so these are often not traced to products.

The hierarchy matters because it tells you why traditional costing distorts. Batch and product level costs do not rise with volume, so volume-based absorption under-costs low-volume products and over-costs high-volume ones.

Key rules to remember

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.

How to solve Concepts and Terminology of Activity Based Costing questions

Use this method for definition questions, classification questions and short numerical questions on ABC terminology.

1Identify the activities named in the question and note what each one actually does.
2Decide the level of each activity: ask whether it happens per unit, per batch, per product line or for the whole plant.
3Group related costs into a cost pool for each activity. Keep each overhead in only one pool.
4Choose the cost driver: pick the measure that best explains why the cost rises or falls, for example number of orders for purchasing.
5Label the driver correctly: a resource driver links resources to activities, an activity driver links activities to products.
6If numbers are given, compute cost driver rate = pool cost ÷ driver quantity.
7Multiply the rate by each product's driver usage, and total the pools for each product.
8Add one line of interpretation, such as which product was under-costed by traditional costing.

Quickest way: Level-and-driver shortcut

When to use it: Use it for MCQs and short classification questions where you must match an activity to its level or driver.

Ask: if I double the units in the same batch, does this cost double? If yes, it is unit level.
If the cost depends on the number of runs or batches, it is batch level.
If it exists because the product exists, whatever the volume, it is product level.
If it keeps the whole plant running, it is facility level.
For the driver, pick the count of the event that triggers the cost, such as set-ups, orders or inspections.
In MCQs, resource driver means resource to activity, activity driver means activity to product.

Common mistakes in Concepts and Terminology of Activity Based Costing

Treating resource drivers and activity drivers as the same thing.
Both are called cost drivers and both are used to assign cost.
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.
Students think of all production activities as volume related.
Fix: Set-up happens once per batch, so it is batch level. Test whether cost changes with units or with batches.
Choosing a volume-based driver, such as machine hours, for every activity.
Habit from traditional costing.
Fix: Pick the driver that causes the activity cost, for example number of purchase orders for purchasing.
Confusing a cost pool with a cost centre.
Both are groupings of cost.
Fix: A cost pool is built around an activity and may cut across departments. A cost centre is a location or department.
Forcing facility level costs into product costs by an arbitrary driver.
Students want every rupee of overhead to be assigned.
Fix: State that facility level costs have no causal driver and are kept separate or spread arbitrarily, if the question says so.

Worked examples

Example 1

A company has the following activities: (a) machining each unit, (b) machine set-up for each production run, (c) designing Product X, (d) factory building rent. Classify each activity in the ABC cost hierarchy and suggest one cost driver for each.

Show the solution

Machining each unit is performed for every unit made, so it is unit level. Driver: machine hours.
Set-up for each run is performed per batch, so it is batch level. Driver: number of set-ups.
Designing Product X exists to support that product regardless of volume, so it is product level. Driver: number of design hours or engineering change orders.
Factory building rent supports the whole plant, so it is facility level. No true causal driver exists, so it is usually not traced to products.

Answer: (a) Unit level, machine hours; (b) Batch level, number of set-ups; (c) Product level, design hours or change orders; (d) Facility level, no causal driver.

Example 2

The inspection cost pool of a plant is ₹3,60,000 for the period. Total inspections carried out are 1,200. Product A needed 200 inspections and Product B needed 100 inspections. Compute the inspection cost charged to each product, and identify the type of driver used.

Show the solution

Cost driver rate = ₹3,60,000 ÷ 1,200 inspections = ₹300 per inspection.
Product A = 200 × ₹300 = ₹60,000.
Product B = 100 × ₹300 = ₹30,000.
Number of inspections links the activity to products, so it is an activity driver.

Answer: Rate ₹300 per inspection; Product A ₹60,000; Product B ₹30,000. The driver is an activity driver.

Exam tips

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.
In numerical questions, show the driver rate with units, such as ₹300 per inspection, before charging products.
In MCQs, read the activity trigger carefully. 'Per batch' and 'per unit' change the answer.

Practice questions from Activity Based Costing

Concepts and Terminology of 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.

Concepts and Terminology of Activity Based Costing: frequently asked questions

What is the difference between a cost pool and a cost driver?

A cost pool is the total cost collected for an activity. A cost driver is the measure that explains why that cost changes and is used to charge it to products. You divide the pool by the driver quantity to get the rate.

What is the difference between a resource driver and an activity driver?

A resource driver assigns resource costs, such as salaries or power, to activities. An activity driver assigns the activity cost pool to products or customers. Resource drivers work in stage one and activity drivers in stage two.

Why are facility level costs not traced to products in ABC?

Facility level costs support the whole plant and do not change with any product, batch or unit. Because no causal driver exists, any assignment would be arbitrary. They are often kept separate or spread on a broad base.

What are the features of Activity Based Costing?

ABC treats activities as the cause of cost and uses multiple cost pools. It uses several cost drivers rather than one volume base. It traces overheads to products by their consumption of activities, giving more accurate product costs.