Activity based costing - part 1

In this lesson

1. 0:00 Activity-Based Costing introduction
2. 1:29 ABC versus Absorption Costing limitations
3. 4:22 Why ABC matters in modern manufacturing
4. 9:24 ABC mechanics and process steps
5. 13:14 Summary: Allocating costs to products

About this lesson

You'll discover what cost drivers are, why they matter, and how ABC breaks down complex production processes into individual activities to assign costs far more accurately. This is crucial for Performance Management (PM) and Management Accounting (MA) papers, where understanding overhead behaviour directly impacts your ability to make sound business decisions and set realistic product pricing. Activity-Based Costing emerged in the 1970s and 1980s as a response to real changes in manufacturing. Where traditional factories relied heavily on direct labour and materials, modern production environments are dominated by overheads—but overheads that behave very differently from one another. The old assumption that all overheads are fixed, or that high-volume products automatically consume more resources, simply doesn't hold anymore. ABC tackles this by mapping the actual activities required to make a product and identifying what drives costs in each one. Whether it's supplier ordering, equipment setup, or quality inspections, each activity gets its own cost driver—the factor that explains why resources are consumed. The mechanics are straightforward but powerful. You estimate total overhead costs, break the business into its key activities, identify the cost driver for each activity, calculate a cost driver rate, and then use those rates to charge costs to your products or services. This approach gives you far greater accuracy than blanket overhead absorption, which matters enormously when you're setting prices, evaluating product profitability, or deciding which lines to expand. The complexity pays off: ABC reveals which products genuinely consume the most resources and which ones are being unfairly burdened by traditional costing methods.

Duration: 14m