Most organizations that use activity-based costing have two costing systems—the official costing
system that is used for preparing external financial reports and the activity-based costing system that
is used for internal decision making and for managing activities.
As noted above, traditional absorption costing is designed to provide data for external financial
reports. In contrast, activity-based costing is designed for use in internal decision making.
Overhead cost pool: A group of overhead cost elements
Activity: Is any event that causes the consumption of overhead resources.
Activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the
Activity measure is an allocation base in an activity-based costing system. The term cost driver is also used to
refer to an activity measure because the activity measure should “drive” the cost being allocated.
The two most common types of activity measures are transaction drivers and duration drivers.
Transaction drivers are simple counts of the number of times an activity occurs such as the number of bills
sent out to customers.
Duration drivers measure the amount of time required to perform an activity such as the time spent
preparing individual bills for customers. In general, duration drivers are more accurate measures of resource
consumption than transaction drivers, but they take more effort to record. For that reason, transaction drivers
are often used in practice.
If plant wide overhead costs do not move in tandem with plant wide direct labour-hours or machine-
hours, product costs will be distorted. Activity-based costing addresses this issue by defining five levels of
activity—unit-level, batch-level, product-level, customer-level, and organization-sustaining—of which only the
costs and corresponding activity measures for unit-level activities relate to the volume of units produced.
Unit-level activities are performed each time a unit is produced.
Batch-level activities are performed each time a batch is handled or processed, regardless of how many units
are in the batch.
Product-level activities relate to specific products and typically must be ca