Activity-Based Costing for Overhead Allocation
Identify one or more cost drivers.
Scrutinize the nature of your overhead to identify different pools of overhead costs and specific measures that affect them. For example, one overhead pool may be storage costs. This pool would be affected by the number of square feet assigned to each department. Ideally, try to identify a single measure that actually causes each overhead pool to increase.
Research the nature of your overhead to try to find measurable factors that affect overhead costs. Ideally, try to find a measure that actually causes the total overhead pool to increase.
Activity-based costing doesn’t prohibit using direct labor hours to allocate overhead. If managers decide direct labor hours are a cost driver, that measure can function as part of the activity-based costing system.
This process eventually results in breaking total overhead down into several different cost pools and identifying a single cost driver for each.