ACTIVITY BASED COSTING is a twostage product costing method that

assigns costs first to activities and

then to the products based on each
products use of activities.

Developing Activity-Based Costs

Activity-based costing involves the
following four steps:

2. Identify the cost driver(s) associated

with each activity.
3. Compute a cost rate per cost driver
unit or transaction.
4. Assign costs to products by
multiplying the cost driver rate by the
volume of cost driver units consumed
by the product.

1. Identify the activitiessuch as

processing ordersthat consume
resources and assign costs to them.
2. Identify the cost driver(s) associated
with each activity. A cost driver
causes, or drives, an activitys costs.
For the order-processing activity, the
cost driver could be the number of
orders.
3. Compute a cost rate per cost driver
unit or transaction. The cost driver
rate could be the cost per order, for
example.
4. Assign costs to products by
multiplying the cost driver rate by the
volume of cost driver units consumed
by the product. For example, the cost
per order multiplied by the number of
orders processed for a particular song
during the month of March measures
the cost of the order processing
activity for that song during March.

4 steps of developing activity based

costs
1. Identify the activities.

Different cost allocation methods

result in different estimates of how
much it costs to make a product.
Activity-based costing provides more
detailed measures of costs than do
plantwide or department allocation
methods.
Production also benefi ts because
activity-based costing provides
better information about how much
each activity costs. In fact, it helps
identify cost drivers (that is, the
activities that cause costs) that
previously were unknown. To
manage costs, production managers
learn to manage the cost drivers.
Activity-based costing provides more
information about product costs but
requires more recordkeeping.

Managers must decide whether the

benefi ts of improved decisions
justify the additional cost of activitybased costing compared to
department or plantwide allocation.

Installing activity-based costing

requires teamwork between
accounting, production, marketing,
management, and other nonaccounting employees.