# A1: Specialist Cost and Management Accounting Techniques | Activity Based Costing (ACCA F5)

Activity Based Costing identifies the appropriate cost drivers under ABC, calculates costs per driver and per unit and compares activity based costing and traditional methods of overhead absorption.

## Activity Based Costing

Costing determines the costs of products, services or activities. Indirect costs or overheads are the costs that are incurred when producing a good or service, but they cannot be traced directly to what was produced. Absorption costing is a method of allocating a fair share of these costs into the cost of each unit of good produced or service provided.

### a) Identify appropriate cost drivers under ABC.

Activity based costing is an alternative to absorption costing. It involves the identification of cost drivers which are responsible for driving the costs of activities. Under ABC, overheads are allocated to cost centres or cost pools and then absorbed into the product costs based on how much they are used for the activity.

Note: A cost driver is a factor that has the most influence or impact on the cost of an activity.

Examples of cost drivers are:

• Number of orders
• Number of production runs
• Number of machine set-ups
• Number of machine hours
• Number of production runs
• Number of orders dispatched

### b) Calculate costs per driver and per unit using ABC.

To calculate the costs per driver and per unit  using ABC:

1. Identify the main activities that result in overheads (assembling goods, filling orders etc.)
2. Determine what the cost driver is (e.g. assembling goods hours, number of orders to be filled)
3. Calculate the cost for each activity (e.g. total cost for assembling goods and filling orders)
4. Calculate the absorption rate for each cost driver
5. Calculate the total overhead cost for each product manufactured
6. Calculate the overhead cost per unit for each good or service

For examples, please refer to the BPP’s ACCA F5 Performance Management Study Text and Open Tuition’s Study Notes and video lectures.

### c) Compare ABC and traditional methods of overhead absorption based on production units, labour hours or machine hours.

#### Activity Based Costing vs. Absorption Based Costing

Cost Drivers

• Activity Based Costing takes many cost drivers into account
• Absorption Costing takes a few cost drivers into account

Product Units

• Activity Based Costing traces the costs of individual units
• Absorption Costing allocates to all units

Size of Company

• Activity Based Costing works well in large operations
• Absorption Costings is better suited to small operations