Activity-Based Costing for Manufacturers

In a manufacturing company, overheads such as machine set-up time, quality control, purchasing and planning may be allocated to products with a single base. That base may be a measure tied to production volume. Yet some overheads arise not from volume but from the number or complexity of transactions. A product made in small batches needs many machine set-ups and quality checks even if its total volume is low. Activity-based costing makes this relationship visible.

Basic steps

1. Identify the activities: The main tasks that generate overheads, for example machine set-up, quality control, purchase orders, shipment preparation.
2. Build cost pools: Collect the costs belonging to each activity (staff, materials, share of depreciation).
3. Choose the cost driver: The measure of the activity’s volume, for example number of set-ups, inspections or orders.
4. Calculate the activity rate: Pool amount ÷ total driver quantity.
5. Assign to products: Driver quantity used by each product × activity rate.

Hypothetical example

Hypothetical example — not based on a real company.

A company has overheads of TRY 200,000 for the period and two products: a high-volume standard product S and a low-volume custom product C.

Information	Product S	Product C	Total
Units produced	10,000	1,000	11,000
Direct labour hours	8,000	2,000	10,000
Machine set-ups	10	50	60
Quality inspections	100	300	400

Traditional allocation (labour hours): 200,000 ÷ 10,000 hours = TRY 20 per hour. S receives 8,000 × 20 = TRY 160,000 (TRY 16 per unit) and C receives 2,000 × 20 = TRY 40,000 (TRY 40 per unit).

Activity-based allocation: Suppose TRY 120,000 of the overhead comes from machine set-up and TRY 80,000 from quality control.

Activity	Pool (TRY)	Driver	Rate	Product S	Product C
Machine set-up	120,000	60 set-ups	TRY 2,000 per set-up	10 × 2,000 = 20,000	50 × 2,000 = 100,000
Quality control	80,000	400 inspections	TRY 200 per inspection	100 × 200 = 20,000	300 × 200 = 60,000
Total	200,000			40,000	160,000
Per unit				TRY 4	TRY 160

Total overhead is TRY 200,000 under both methods; only the distribution changes. The traditional method assigns TRY 40 per unit to product C, while ABC assigns TRY 160. If C’s price was set on traditional cost, the product is less profitable than it appears, or may be loss-making. Product S, on the other hand, may be priced higher than necessary in the market because it carries too much overhead.

When does it add value?

• When product or customer variety is high,
• when batch sizes and order complexity differ widely between products,
• when overheads are a large share of total cost,
• when pricing or product range decisions are contested.

In businesses making a single type of product, or where overheads are a small share, the difference may not justify the set-up effort.

Points to watch in practice

• Start with a few activities: A few activities that explain the bulk of the overhead may be enough. Too many make the data hard to maintain.
• Reliability of driver data: If set-ups or inspections are not recorded, set up data collection first.
• Idle capacity: If activity rates are calculated as if all capacity were used, the cost of unused capacity is loaded onto products. On this topic, see the cost of idle capacity.
• Link to statutory reporting: For entities applying TFRS, TMS 2 (the Turkish equivalent of IAS 2) requires production overheads to be allocated systematically to costs of conversion (paragraph 12) and fixed production overheads to be based on normal capacity (paragraph 13); some costs, such as selling costs, are excluded from inventory (paragraph 16). Activity-based drivers can be used within these limits. Entities applying BOBİ FRS account for inventories under Section 6 of that standard.

Common mistakes

• Treating ABC as an accounting project: The aim is decision support; sales and production teams should take part.
• Leaving the result as a one-off exercise: Driver rates should be updated at least annually.
• Loading all fixed costs onto products: Corporate costs unrelated to products can distort product decisions.

What it means for management

Activity-based costing gives a more realistic answer to the question “which product really makes money?”. Its greatest value is making the cost of complexity visible: small batches, special orders and frequent changes. This information can be used directly in pricing, minimum order quantities and product range decisions. For the move to product profitability analysis, see product profitability.

Sources last checked: 21 October 2026