raditionally, in a job order cost system and process cost system, overhead is allocated to a job or function based on direct labor hours, machine hours, or direct labor dollars. However, in some companies, new technologies have changed the manufacturing environment such that the number of hours worked or dollars earned by employees are no longer good indicators of how much overhead will be needed to complete a job or process products through a particular function. In such companies, activity‐based costing (ABC) is used to allocate overhead costs to jobs or functions.Activity‐based costing assumes that the steps or activities that must be followed to manufacture a product are what determine the overhead costs incurred. Each overhead cost, whether variable or fixed, is assigned to a category of costs. These cost categories are called activity cost pools. Cost drivers are the actual activities that cause the total cost in an activity cost pool to increase. The number of times materials are ordered, the number of production lines in a factory, and the number of shipments made to customers are all examples of activities that impact the costs a company incurs. When using ABC, the total cost of each activity pool is divided by the total number of units of the activity to determine the cost per unit.
