Activity-Based Costing (ABC) assigns costs to products

Solution

Activity-based costing (ABC) assigns overhead and indirect costs to products by first tracing expenses to activities and then to products based on usage. It improves accuracy by identifying specific activities (e.g., machine setups, inspections) as cost drivers rather than allocating based solely on volume, such as direct labor hours.  Note – ABC and traditional costing, are the two methods for allocating indirect (overhead) costs to products. Both methods estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The differences are in the accuracy and complexity of the two methods. Traditional costing is more simplistic and less accurate than ABC and typically assigns overhead costs to products based on an average rate. ABC is more complex and more accurate than traditional costing, as it provides a more precise breakdown of indirect costs as per activities consumed by the product.