In ABC, after grouping overheads into cost pools and identifying cost drivers, which step comes next?

In ABC, after grouping overheads into cost pools and identifying cost drivers, which step comes next?

• A. Calculate cost driver rates (budgeted cost pool/budget cost driver)
• B. Absorb overheads based on demand
• C. Determine production quantity
• D. Set a single overhead rate

Answer: (A)

Once overheads have been grouped into cost pools and their drivers identified, the next step is to translate those budgets into a usable price for each driver. This means calculating the cost driver rates by dividing the budgeted overhead for each pool by the budgeted level of its driver. These rates become the amounts used to apply or absorb overheads to products or services based on actual consumption of each driver. For example, if a pool has budgeted overhead of £120,000 and the driver is 24,000 machine hours, the rate is £5 per machine hour. When actual hours are known, you multiply by the rate to allocate overhead accordingly. Absorbing overheads based on demand is something you do after the rates exist; production quantity is not what creates the rate in ABC, and using a single overhead rate contradicts the multiple-rate approach of activity-based costing.

Once overheads have been grouped into cost pools and their drivers identified, the next step is to translate those budgets into a usable price for each driver. This means calculating the cost driver rates by dividing the budgeted overhead for each pool by the budgeted level of its driver. These rates become the amounts used to apply or absorb overheads to products or services based on actual consumption of each driver.

For example, if a pool has budgeted overhead of £120,000 and the driver is 24,000 machine hours, the rate is £5 per machine hour. When actual hours are known, you multiply by the rate to allocate overhead accordingly.

Absorbing overheads based on demand is something you do after the rates exist; production quantity is not what creates the rate in ABC, and using a single overhead rate contradicts the multiple-rate approach of activity-based costing.