8.3 Activity Based Costing (ABC)
Apportioning (called ' absorbing') overheads on the basis of direct labour hours, or some other measure, is a very traditional approach and was derived during a time when most production centred on labour. Businesses had large labour forces and work was labour intensive. Comparatively small amounts of money were spent on overheads. The market at that time was not particularly competitive.
Times have changed. By the 1990's much of the world's production had become capital-intensive, as there was a swing to machine-based production. The cost of overheads, as compared to direct costs, increased significantly as machines need power, and more money is spent on machines themselves leading to larger depreciation amounts. Modern industry also incurs more costs associated with the welfare of its staff and the community in which it operates. The market is now highly competitive and barriers to international trade have been lifted or lessened so that the market and competition is worldwide or 'global'.
Historically, the overhead recovery rate was much less than the direct labour hourly rate paid to the workers. In recent times the overhead recovery rate has been as much as five and ten times the rate paid to employees.
Text reading
Atrill, Concentrate on following the reasoning of Example 8.3.
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