This lesson introduces Activity-Based Costing, a modern costing system that assigns overhead costs to products based on the activities that drive those costs. It is a response to the limitations of traditional absorption costing in complex, overhead-heavy environments. ABC is a key component of the US CMA syllabus .

• The Problem with Traditional Costing: Traditional absorption costing often uses a single, volume-based rate (like direct labour hours) to allocate overhead. This can lead to inaccurate product costs in modern environments where overhead costs are large and driven by factors other than volume (e.g., the number of set-ups, purchase orders).

• The ABC Process: ABC involves several steps:

  1. Identify Activities: Identify the key activities performed in the organisation (e.g., setting up machines, processing orders, handling materials).

  2. Assign Costs to Activities: Trace costs (overheads) to these activities based on their consumption of resources (activity cost pools).

  3. Identify Cost Drivers: For each activity, identify a cost driver that best reflects the cause of the activity (e.g., number of set-ups, number of orders processed).

  4. Calculate Activity Rates: Compute a rate for each activity cost driver (e.g., cost per set-up).

  5. Assign Costs to Products: Assign activity costs to products based on the product’s consumption of each activity (e.g., number of set-ups required for a product).

• Benefits and Limitations: ABC provides more accurate product costs, especially in complex businesses, leading to better pricing and product mix decisions. However, it can be more expensive and time-consuming to implement and maintain than traditional systems .