Explain how activity-based costing works
Trace overhead from activities to products using cost pools and drivers that reflect resource use.
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. Topic 4.1 covers activity-based costing (ABC), cost drivers, overhead apportionment and allocation, unit cost and selling-price calculations, method comparisons, uses and limitations, and supported decisions. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use AS Topic 2.1–2.2 knowledge of fixed and variable costs, overhead absorption, cost-plus pricing and contribution. This A Level pathway compares those methods with activity-based costing.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which method commonly uses one volume base to absorb overhead?
What you will learn
- Define activity-based costing and a cost pool
- Explain the role of activity cost drivers
- Contrast ABC with a single volume-based absorption rate
Trace overhead through activities
Activity-based costing (ABC) groups overhead into activity cost pools, then assigns each pool to products using a cost driver linked to the activity. Examples can include set-ups, inspections, purchase orders, deliveries or machine processing, depending on what causes the cost in the business.
A traditional method may absorb overhead using one or a small number of volume bases such as labour hours or machine hours. ABC uses more than one driver when different activities consume resources differently; it is not automatically more accurate unless the pools, drivers and data are suitable.
Follow the calculation sequence
Identify overhead activities and form cost pools. Choose a driver that reasonably represents the cause of each pool. Calculate the driver rate as pool cost divided by total driver units, then multiply that rate by each product's driver use to allocate overhead.
Add allocated overhead to the relevant direct costs and divide by output to find cost per unit. If a selling price is required, apply the pricing rule stated in the question; do not assume ABC itself sets a market price.
Pause and explain
What is the first ABC calculation after the cost pools and total driver units are identified?
Worked example
A factory has a set-up cost pool of $80,000 and 160 set-ups, and a machine pool of $180,000 and 5,000 machine hours. Calculate each driver rate.
Show the worked solution
- Set-up rate = $80,000 ÷ 160 = $500 per set-up.
- Machine rate = $180,000 ÷ 5,000 = $36 per machine hour.
- Each product is charged according to its own use of each driver.
Answer The rates are $500 per set-up and $36 per machine hour.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A delivery pool costs $36,000 and the business makes 240 deliveries. Calculate the rate.
Give me a hint
Divide the cost of the delivery activity by deliveries.
Compare my reasoning
- $36,000 ÷ 240 deliveries = $150 per delivery.
- Keep the driver unit in the rate label.
- Products are charged $150 for each delivery they use.
The delivery driver rate is $150 per delivery.
Look for these in your work
- Use delivery pool cost as numerator.
- Divide by 240 deliveries.
- Label the rate per delivery.
An inspection pool costs $48,000 for 240 inspections. Product A uses 60 and Product B uses 180. Calculate the rate and each product's allocation.
Give me a hint
Calculate one pool rate, then multiply by each product's inspection count.
Compare my reasoning
- Rate = $48,000 ÷ 240 = $200 per inspection.
- A allocation = 60 × $200 = $12,000.
- B allocation = 180 × $200 = $36,000; together they reconcile to $48,000.
The rate is $200 per inspection; A receives $12,000 and B receives $36,000.
Look for these in your work
- Calculate the pool rate as $200 per inspection.
- Allocate $12,000 to A.
- Allocate $36,000 to B and reconcile to the pool.
A manager says ABC is always better because it uses more rates. Explain why that claim is too broad.
Give me a hint
Consider data quality, cost of measurement and whether the extra detail changes a decision.
Compare my reasoning
- More drivers can reflect different activity use more closely when they are causal and measured reliably.
- If drivers are poor proxies or data is expensive to collect, the allocations may still mislead and cost more than the benefit.
- Compare decision relevance, accuracy, collection cost and the business's range of products before recommending ABC.
ABC can improve cost information when its drivers reflect resource use, but it can be costly or misleading when data and drivers are weak.
Look for these in your work
- Link accuracy to a valid driver.
- Recognise implementation and data costs.
- Make the recommendation depend on decision benefit.
Common mistakes
- Treating a cost driver as just any convenient measurement
- Applying a single rate to all products after calculating multiple pools
- Assuming ABC must always produce a better decision
What can you explain now?
What is the role of a cost driver in ABC?
Compare with the explanation
It measures activity use to allocate the related cost pool
A driver links the activity pool to the products consuming the activity.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
State the ABC sequence from overhead activity to product cost.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.