Traditional cost accounting spreads out overhead and indirect costs over product cost, based on a random and inaccurate driver such as manufacturing cost, labor hours, units sold, revenue, etc. This results in over- and under-allocation of some products and customers, which can distort the profitability of products and customers. This can lead to misinformed management, and decisions to prioritize certain products or customers can have disastrous outcomes because of it.

Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.

ABC is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy.

Step by Step ABC calculation is as follows:

· Identify all the activities required to create the product.

· Divide the activities into cost pools, which include all the individual costs related to an activity—such as manufacturing. Calculate the total overhead of each cost pool.

· Assign each cost pool activity cost drivers, such as hours or units.

· Calculate the cost driver rate by dividing the total overhead in each cost pool by the total cost drivers.

· Divide the total overhead of each cost pool by the total cost drivers to get the cost driver rate.

· Multiply the cost driver rate by the number of cost drivers.

In this course we will take you through the practical aspects of each step one by one.