1. Introduction and Objectives
Activity-Based Costing (ABC) was developed by Robert Kaplan and William Burns to address the limitations of traditional volume-based allocation. ABC assigns overhead costs based on the actual activities that drive those expenses, providing a more precise picture of product and service costs.
 
2. The Two-Stage ABC Cost Assignment Flow
Instead of assigning costs directly from departments to products, ABC introduces an intermediate layer based on activities:
[Resource Costs / Expenses Ledger] ──> Resource Drivers ──> [Activity Cost Pools]
                                                                  │
                                                                  â–¼
[Final Cost Objects / Products]    <──  Activity Drivers ──< [Cost Drivers]

3. Core Operational Terminology
  • Activity Cost Pool: A collection of costs related to a specific operational task (e.g., machine setups, quality inspections, material handling).
  • Cost Driver: The specific metric that dictates how much work an activity requires.
    • Transaction Drivers: Count how often an activity occurs (e.g., number of production runs).
    • Duration Drivers: Measure the time an activity takes to complete (e.g., hours spent setting up a machine).

4. The Cost Hierarchy Classification
ABC groups operational activities into four standard levels to clarify how costs scale:
  • Unit-Level Activities: Performed each time a single unit is produced (e.g., machine electricity).
  • Batch-Level Activities: Performed each time a fresh batch of goods is processed, regardless of size (e.g., machine setups, production scheduling).
  • Product-Sustaining Activities: Performed to support specific product lines, regardless of volume or batches (e.g., product design updates, engineering changes).
  • Facility-Sustaining Activities: General operations that support the entire facility and cannot be traced to specific products or batches (e.g., factory rent, plant security).

 
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