To maintain simplicity, the Stassen example in this chapter assumed that all costs were either variable or fixed. In particular, there were no batch-level costs and no product-sustaining costs. It is easy to see that the distinction between variable and absorption costing carries over directly into activity-based costing systems, with batch-level costs acting as variable costs and product-sustaining ones as fixed costs.
In order to focus on the choice of denominator to calculate the budgeted fixed manufacturing cost rate, our Stassen example assumed that all fixed manufacturing costs had a single cost driver: telescope units produced. As you saw in Chapter 5, activity-based costing systems have multiple overhead cost pools at the output-unit, batch, product-sustaining, and facility-sustaining levels—each with its own cost driver. In calculating activity cost rates (for fixed costs of setups and material handling, say), management must choose a capacity level for the quantity of the cost driver (such as setup-hours or loads moved). Should management use practical capacity, normal capacity utilization, or master-budget capacity utilization? For all the reasons described in this chapter (such as pricing and capacity management), most proponents of activity-based costing argue that managers should use practical capacity as the denominator level to calculate activity cost rates.