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The concepts or assumptions underlying ABC are:
§ In the long run, all overhead costs are variable. Some overheads are variable in the short run. However, overhead costs do not necessarily vary with production volume or service level.
§ Activities consume resources.
§ The consumption of resources drives cost.
Products incur overhead costs because of the activities that go into providing the products or services, and these activities are not necessarily related to the volumes of the product that are manufactured. Direct labour hours and machine hours are not the drivers of cost in many modern business environments.
Understanding the relationship between overhead costs, activities and products (or services) is essential for managing overhead costs and product or service profitability.
Absorption of overheads into unit costs on a volume basis may be misleading, particularly in a modern manufacturing environment where overhead costs are influenced by the diversity and complexity of output rather than volume.
