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Activities basically fall into four different categories, known as the manufacturing cost hierarchy. These categories are generally accepted today but were first identified by Cooper (1990). The categories of activities help to determine the type of activity cost driver required.
The categories of activities are :
1. Unit level activities. The costs of some activities (mainly primary activities) are strongly correlated to the number of units produced. For example, the use of indirect materials/consumables tends to increase in proportion to the number of units produced.
Another example of a unit level activity is the inspection or testing of every item produced, if this was deemed necessary or, perhaps more likely, every 100th item produced.
2. Batch level activities. The cost of some activities (mainly manufacturing support activities) are driven by the number of batches of units produced. Examples of this are :
• Material ordering–where an order is placed for every batch of production
• Machine set-up costs–where machines need resetting between each different batch of production.
• Inspection of products–where the first item in every batch is inspected rather than every 100th item quoted above.
• Inspection of products–where the first item in every batch is inspected rather than every 100th item quoted above.
3. Product level activities. The costs of some activities (often once only activities) are driven by the creation of a new product line and its maintenance, for example, designing the product, producing parts specifications and keeping technical drawings of products up to date. Advertising costs fall into this category if individual products are advertised rather than the company’s name.
4. Facility level activities. Some costs cannot be related to a particular product line, instead they are related to maintaining the buildings and facilities. Examples are the maintenance of buildings, plant security, business rates, etc. Also included in this category are salaries, such as the production manager’s. Advertising campaigns that promote the organisation would also be included.
The first and last categories above are the same as those in traditional absorption costing and so if an organisation costs are mainly made up of these two categories ABC, will not improve the overhead analysis greatly. But if the organisation’s costs fall mainly in the second and third categories an ABC analysis will provide a different and more accurate analysis.
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