1. Step 1: Identify and Group Activities
Interview staff, review work processes, and assign all indirect overhead resources to distinct activity cost pools.
 
2. Step 2: Compute Activity Rates
For each cost pool, identify its primary cost driver, track the total volume of that driver, and calculate a standardized charging rate:
“Activity Pool Rate” = “Total budgeted cost”/”Total expected amount of the cost driver”
 
3. Step 3: Assign Costs to Products
Multiply the calculated activity pool rate by the actual number of driver events consumed by a specific product line:
“Overhead assigned to a product” = “Activity rate” × “How much of the activity the product uses”
Worked Comparative Scenario
A factory incurs $100,000 in total setup overhead costs and runs 200 total setups per year, resulting in an ABC setup rate of $500 per setup.
  • Product A (Standard): Runs 10,000 units in 2 large batches (2 setups). ABC assigns $1,000 total setup overhead ($0.10 per unit).
  • Product B (Custom): Runs 500 units in 10 small batches (10 setups). ABC assigns $5,000 total setup overhead ($10.00 per unit).
  • Contrast: Traditional allocation would have spread the $100,000 flatly based on total production volume, hiding Product B’s massive setup costs.
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