How does ABC differ from traditional costing?

How does ABC differ from traditional costing?

• A. It allocates overhead by activities and cost drivers rather than only volume-based allocation, improving precision for indirect costs.
• B. It allocates overhead solely by direct labor hours.
• C. It uses only machine hours to allocate overhead.
• D. It is used only in service industries.

Answer: (B)

Activity-based costing allocates overhead based on the actual activities that drive costs, not just a single volume measure. Traditional costing often spreads indirect costs using a single base like direct labor hours (or machine hours), assuming overhead varies in step with that one measure. ABC recognizes that different products or services consume different activities—setup, inspection, material handling, order processing, and more—and assigns overhead to products according to how much of each activity they require, using drivers such as the number of setups, inspection hours, or units moved. This approach yields a more accurate picture of true product costs, especially when overhead is significant or products differ in their use of overhead activities. The other statements describe traditional costing (allocating by direct labor or machine hours) or a restriction (ABC being used only in service industries), which do not fit ABC.

Activity-based costing allocates overhead based on the actual activities that drive costs, not just a single volume measure. Traditional costing often spreads indirect costs using a single base like direct labor hours (or machine hours), assuming overhead varies in step with that one measure. ABC recognizes that different products or services consume different activities—setup, inspection, material handling, order processing, and more—and assigns overhead to products according to how much of each activity they require, using drivers such as the number of setups, inspection hours, or units moved.

This approach yields a more accurate picture of true product costs, especially when overhead is significant or products differ in their use of overhead activities. The other statements describe traditional costing (allocating by direct labor or machine hours) or a restriction (ABC being used only in service industries), which do not fit ABC.