1. The Two-Stage Allocation Philosophy
Activity-Based Costing (ABC) recognizes that products do not directly consume overhead resources; products consume activities, and activities consume resources. ABC traces costs through a two-stage process:
  Stage 1: [ Resource Costs ] -----------> Allocated to ----------> [ Activity Cost Pools ]
                                                                             |
  Stage 2: [ Activity Cost Pools ] -------> Traced via Drivers ---> [ Product Cost Objects ]

2. Definitional Framework Components
  • Resource Costs: Total operating expenditures incurred by the enterprise (e.g., factory electricity, engineering salaries).
  • Activity Cost Pools: Bins where costs are gathered based on specific tasks performed (e.g., machine setups, material handling, purchase order processing).
  • Activity Cost Drivers: The specific operational metrics that measure how much work an activity pool performs for a product (e.g., number of setups, number of parts, number of orders).

3. Designing a Cost Driver Hierarchy
To stay organized, ABC groups activities into four distinct operational tiers:
+-------------------+---------------------------------------+------------------------------------------+

| Hierarchy Level   | Operational Definition                | Representative Cost Driver Example       |
+-------------------+---------------------------------------+------------------------------------------+

| Unit-Level        | Activities performed every single time | Machine hours, direct labor hours,       |
|                   | a unit of product is manufactured.     | electricity kilowatt-hours.              |
+-------------------+---------------------------------------+------------------------------------------+

| Batch-Level       | Tasks triggered by groups of units    | Number of machine setups, number of      |
|                   | processed together at one time.       | production runs, material moves.         |
+-------------------+---------------------------------------+------------------------------------------+

| Product-Sustaining| Activities performed to support a     | Engineering design hours, number of      |
|                   | specific product line, regardless of  | testing protocols, patent updates.       |
|                   | units or batches made.                |                                          |
+-------------------+---------------------------------------+------------------------------------------+

| Facility-Sustaining| General administrative and facility   | Factory square footage, site security,   |
|                   | costs required to keep the plant open. | building insurance.                      |
+-------------------+---------------------------------------+------------------------------------------+

 
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