Activity-based costing (ABC) can have a role in process settings provided
a. only direct costs are incurred in the process of manufacturing.
b. there is only one activity driver.
c. multiple products are being produced.
d. a predetermined overhead rate is used to assign direct costs.
The correct answer and explanation is:
The correct answer is c. multiple products are being produced.
Activity-Based Costing (ABC) is a costing method used to allocate overhead costs to products or services based on the activities that drive those costs. Unlike traditional costing methods, which assign costs based on a single cost driver (like labor hours or machine hours), ABC assigns costs more accurately by identifying the specific activities that incur costs and assigning them to the products that use those activities.
ABC is particularly useful in process settings where multiple products are being produced. This is because, in such settings, overhead costs are often driven by several different activities, and each product may consume different amounts of those activities. By using ABC, an organization can more precisely allocate the costs to the products that actually use those resources. For instance, a company that produces both high-volume and low-volume products will likely have different overhead cost drivers for each product. ABC helps capture these nuances, leading to a more accurate cost allocation.
Here’s why the other options are not correct:
- a. only direct costs are incurred in the process of manufacturing: Direct costs, such as materials and labor, can be traced directly to a product. ABC focuses on indirect or overhead costs, which are not directly traceable to products but are instead spread across multiple activities. Therefore, ABC is not used to allocate only direct costs.
- b. there is only one activity driver: While having one activity driver simplifies the process, ABC is designed to account for multiple activity drivers. In real-world scenarios, multiple activities often drive overhead costs, and ABC can handle that complexity.
- d. a predetermined overhead rate is used to assign direct costs: Predetermined overhead rates are commonly used in traditional costing systems, not in ABC. In ABC, overhead costs are assigned based on actual activity consumption, not predetermined rates.
ABC is an effective method for organizations that produce multiple products, especially when those products require different levels of overhead consumption. It allows for more accurate product costing, which can help in pricing decisions, profitability analysis, and process improvements.