Background and professional notes
2-minute explanation: what the result means
Allocate multiple overhead pools using activity drivers and reconcile product-level margins, with unallocated overhead clearly identified.
Worked example for Indian finance teams
If set-up overhead is ₹1,00,000 for 50 machine set-ups, a product using 20 set-ups receives ₹40,000. The allocation rate is ₹2,000 per set-up.
Methodology and audit trail
Calculate each cost-pool rate by dividing total pool cost by its measured driver volume. Multiply rates by the usage attributable to each product. Keep idle capacity or third-product usage separately unallocated rather than forcing it into A or B.
Assumptions and limits of the calculation
ABC is useful when products consume activities in different proportions. Validate operational quantities, set-up batches, warehouse movements and production unit counts. A negative product margin requires investigating pricing and cost-driver quality, not an immediate discontinuation decision.
How to select causal cost drivers
Define the cost object first—products, clients, services or job orders. Separate activity pools that have different drivers; for example, batch set-ups are better driven by batches than output volume, while machine electricity can be related to measured machine-hours. Do not use a cost pool both as direct labour and overhead. Compare the resulting product contribution with a traditional single-rate absorption system to identify cross-subsidisation. ABC may support pricing, make-or-buy and product-mix decisions, but it should not mechanically convert management allocations into statutory inventory values without Ind AS 2 and the applicable cost-accounting treatment.
Documents and evidence to preserve
Activity register, documented driver definitions, allocation-period cut-off, machine logs, set-up reports, dispatch counts, product master, reconciled total overhead ledger.
Frequently asked questions
No. Direct material and direct labour remain direct costs; ABC allocates overheads. Yes, when other products or unused capacity consume drivers; the difference is shown as unallocated. Traditional absorption often uses a single volume driver. ABC uses activity-level causal drivers.
Frequently asked questions
How is ABC different from traditional absorption?
Traditional costing spreads overhead on one base such as labour hours. ABC assigns each pool by the driver that actually causes the cost, so low-volume products often show higher costs.
What if a driver is not fully used by the two products?
The unused part stays unallocated and is shown as such; do not add it to a product without a basis.
How many pools should I use?
Use the few pools that matter. Too many small pools add effort without changing the answer.
Official sources and further reading
Rates and rules were checked against these sources on 11 October 2026. Notifications and standards change; confirm on the official site before you file, book or advise.