}It is a form of absorption costing
}Cost pools and cost drivers
}Rather than absorbing overheads on aproduction volume basis ABC firstly allocates overheads to cost pools before absorbing them into units using cost drivers.
Activity based costing (ABC)
Cost pool
}An activity that incurs cost.
}Costs are linked to the activity accurately and from the activity to the cost unit.
}Knowledge of the activity is key to the application of ABC.
Cost driver
}A cost driver is a unit of activity thatconsumes resource
}This is the causal link between theactivity and the cost unit.
}Cost drivers describe exactly how the production of units will incur costs within the activity.
}The overhead is linked to the cost unit using a cost driver rate.
ABC versus Absorption costing
}Costs would be absorbed based on activity level (e.g. machine hours) and this is inappropriate as the machine hours are not directly responsible for the rent or rates.
}ABC overcomes this problem by not using departments as gathering points for costs, but instead it uses activities to group the costs (cost pools) which are caused (driven) by an activity.
}ABC flexibility reduces the need for arbitrary apportionments.
}Using ABC should lead to more accurate product and/or service costs being calculated.
Advantages and disadvantages of ABC
}When compared to other costing systems ABC has the following advantages and disadvantages.
