Activity based Costing

There will be many areas within a business where overheads are being incurred.

For example, one are might be the departments that receives the materials from suppliers.There might be several different overheads in this department such as rent of the space, wages of the employees in the department, electricity used in the department etc.. We add all the overheads for this department together and the total is called the cost pool.

Then we look at why this department is needed and what it is that determines the number of workers etc. needed. We might decide that it is due to the number of separate deliveries that were being received. We would then call the number of deliveries received the cost driver. (Because if we were to receive fewer deliveries (so more materials each time) then maybe we could reduce our overheads for this department). Dividing the cost pool by the cost driver would in this case give us the overhead cost for each delivery.

Appreciate that you cannot be asked for calculations using ABC in Paper MA – that comes later in Paper PM – but if you want to know more for interest then watch the ABC lectures for Paper PM.