What is activity-based costing (ABC) and its purpose?

What is activity-based costing (ABC) and its purpose?

• A. An overhead allocation method that uses only unit volume.
• B. An overhead allocation method that assigns costs based on direct labor hours.
• C. An overhead allocation method that assigns overhead based on machine hours only.
• D. A costing method that allocates overhead by activities and cost drivers.

Answer: (D)

Activity-based costing looks at the activities that drive overhead costs and assigns those costs to products based on how much each product uses those activities. Its purpose is to improve costing accuracy by using multiple cost drivers tied to actual consumption, rather than spreading overhead with a single volume measure. For example, products that require more setups or inspections will absorb more overhead under ABC, reflecting true resource use. This contrasts with traditional methods that allocate overhead using unit volume, direct labor hours, or machine hours only, which can distort costs. Therefore, overhead is allocated by activities and cost drivers.

Activity-based costing looks at the activities that drive overhead costs and assigns those costs to products based on how much each product uses those activities. Its purpose is to improve costing accuracy by using multiple cost drivers tied to actual consumption, rather than spreading overhead with a single volume measure. For example, products that require more setups or inspections will absorb more overhead under ABC, reflecting true resource use. This contrasts with traditional methods that allocate overhead using unit volume, direct labor hours, or machine hours only, which can distort costs. Therefore, overhead is allocated by activities and cost drivers.