Two contracts to manufacture the same item require identical direct material and direct labor. Contract A has 10 delivery orders and Contract B has 90. A detailed analysis at this company has determined that a significant amount of overhead expense is generated by the activity. Note that the example did not reclassify all indirect cost. The reader should not be misled by the simplicity of the example.
Most companies have multiple cost drivers.
The costs associated with activities are determined after a detailed and sometimes lengthy evaluation of the processes within a company. This involves data collection, interviews, model building, pilot studies, and lots of planning. Not only is the data generated by ABC svstem cost and pricing data, but so is any information gained in the planning stages. The contractor needs to keep appropriate government representatives informed of any cost and pricing data it generates. A company mav find itself in this type of situation.