Variable Activity-Based Costing and Decision Making

Much of managerial decision making regarding product pricing and output depends on a careful separation of the fixed and variable components of costs. Without this separation, the decision maker will be unable to assess the impact of their decisions on profitability. This distinction is particularly relevant in allocating overhead. Both traditional and activity-based costing (ABC) systems are full absorption systems in the sense that they include both fixed and variable production costs in product cost. This mixing of fixed and variable overhead costs results in product costs that are difficult to use in decision making. This article uses a numeric example to compare several alternate approaches to overhead allocation. It highlights variable activity-based costing (VABC), which utilizes regression analysis to estimate the fixed and variable portions of each cost pool. The results show that VABC can produce information that is more useful in decision making and that the resulting cost allocations are superior to traditional costing approaches for decision-making purposes. © 2017 Wiley Periodicals, Inc.