ACCOUNTING DECISIONS 167
and posted. This business process cuts across several departments. ABC collects
the costs in all departments for the purchasingprocessin a cost pool.
A cost driver is then identified. Thecost driveris the most significant cause of
the activity. In the purchasing example, the causes of costs are often recognized
as the number of suppliers and/or the number of purchase orders. Cost drivers
enable the cost of activities to be assigned from cost pools to cost objects. Rates are
calculated for each cost driver and overhead costs are applied to product/services
on the basis of the cost driver rates.
There are no rules about what cost pools and cost drivers should be used, as
this will be contingent on the circumstances of each business and the choices made
by its accountants. Examples of cost pools and drivers are:
Cost pool Cost driver
Purchasing No. of purchase orders
Material handling No. of set-ups (i.e. batches)
Scheduling No. of production orders
Machining Machine hours (i.e. not labour hours)For example, a rate will be calculated for each cost driver (e.g. purchase order,
set-up) and assigned to each product based on how many purchase orders and set-
ups the product has consumed. The more purchase orders and set-ups a product
requires, the higher will be the overhead cost applied to it. ABC does not mean
that direct labour hours or machine hours or the number of units produced are
ignored. Where these are the significant cause of activities for particular cost pools,
they are used as the cost drivers for those cost pools.
Using the same example as for absorption costing, assume for our two products
that there are two cost pools: purchasing and scheduling. The driver for purchasing
is the number of purchase orders and the driver for scheduling is the number of
production orders. Costs are collected by the accounting system into cost pools
and the measurement of cost drivers takes place, identifying how many activities
are required for each product. The cost per activity is the cost pool divided by the
cost drivers, as shown in Table 11.5.
Table 11.5 Overhead accumulated in cost pools and allocated by cost
drivers
Cost pool and driver Total cost Product A Product B
Purchasing £40,000- no. of purchase orders 4,000 3,000 1,000
(£10 each) £30,000 £10,000
Scheduling £60,000 - no. of production orders 100 75 25
(£600 each) £45,000 £15,000
Total overhead £100,000 £75,000 £25,000