## Stages in Activity Based Costing
ABC is implemented in five sequential stages:
1. Identify Activities — structured interviews with key personnel to map all activities (e.g., production scheduling, purchasing, customer liaison).
2. Relate Overheads to Activities — group overhead costs into activity cost pools based on causality (resource cost drivers).
3. Allocate Support Activities — spread support activity costs into primary activity pools using utilisation-based cost drivers.
4. Determine Activity Cost Drivers — identify what drives consumption of each activity pool (links pool → cost object).
5. Calculate Activity Cost Driver Rates — Rate = Total pool cost ÷ Total cost driver units.
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## Advantages of ABC
1. More accurate product/service costing
2. Overhead allocation on logical, causal basis
3. Enables better pricing policies
4. Uses unit cost not just total cost
5. Identifies non-value-added activities → cost reduction
6. Suits organisations with multiple diverse products
7. Highlights problem areas for management attention
## Limitations of ABC
1. Expensive to implement and maintain vs traditional systems
2. Not suitable for small organisations
3. Not useful where product range is limited
4. Selection of the most appropriate cost driver can be difficult or contentious
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## ABC Implementation Requirements
| Stage | Description |
|---|---|
| Staff Training | Create workforce awareness; cooperation is critical |
| Process Specification | Structured interviews to map production stages, resource commitment, bottlenecks |
| Activity Definition | Clearly define activities early to manage information overload |
| Activity Driver Selection | Choose cost driver for each activity |
| Assigning Cost | Use representative activity driver to assign pool costs to cost objects |
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## ABC as a Decision-Making Tool
- Performance & profitability: Combined with other techniques to improve margins
- Wholesale distributors: Better new product/vendor introduction decisions
- Facility expansion: Identifies specific cost elements for relocation/new distribution centre decisions
- HR decisions: Links activity costs to individuals; improves financial performance assessment
- Pricing: Cost-plus pricing using accurate per-unit costs; enables competitive pricing