Activity Based Costing (ABC) differs from Absorption Costing (AC) in the manner in which overheads are charged to units.

ABC charges overheads to units based on their proportionate consumption of the driver of each separate overhead activity

Key Terms

Cost Pool

Cost Driver & Prime Driver

Prime Driver Rates

Activity Based Costing – The Advent of ABC (Ignore Inflation)

Activity Based Costing – Steps

Identify overhead activities

Decide on prime driver of each overhead activity

Record overhead activity cost in cost pools and the number of prime drivers for each overhead activity for the period

Determine the prime driver rates 

Charge overheads to units based on their proportionate consumption of the driver of each separate overhead activity.

Activity Based Costing – Arguments For

Provides a more accurate assessment of unit costs

Underpins the competitive pricing of units on a cost plus basis

Provides an improved insight into the drivers which may lead to cost reduction opportunities

Highlights the cost of overhead activities for benchmarking against best practice/industry averages etc

Helps management assess the value added proposition of internal overhead activities

Activity Based Costing – Arguments Against

Consumes increased resources to identify and record cost pools and cost driver activity

There are many factors which influence the cost of an overhead activity in addition to the prime driver

The selection of the prime driver of each activity is  subjective

It is considered as simply an extension of Absorption Costing (AC)