Which of the following improves the accuracy of product costs when using ABC?
Multiple Choice
Accumulates overhead costs in multiple activity cost pools that represent the major activities, instead of in just one or two pools.
The activity cost pools are less homogeneous than departmental cost pools.
ABC relies just on volume-based allocation bases (such as direct labour-hours or machine-hours) to assign overhead.
ABC relies just on non-volume-based allocation bases to assign overhead.
The correct answer and explanation is :
The correct answer is:
✅ “Accumulates overhead costs in multiple activity cost pools that represent the major activities, instead of in just one or two pools.”
Explanation:
Activity-Based Costing (ABC) is a cost allocation method that enhances the accuracy of product costing by identifying the major activities that consume resources and assigning costs accordingly. Unlike traditional costing systems that use broad overhead allocations, ABC divides costs into multiple activity cost pools, making cost allocation more precise.
- More Granular Cost Allocation:
Traditional cost systems allocate overhead using a single cost pool (e.g., factory-wide overhead). ABC, however, segregates costs into multiple activity cost pools such as material handling, machine setups, quality control, and customer service. This method improves accuracy as it traces costs to specific activities rather than spreading them arbitrarily. - Reduces Distortion in Costing:
In traditional costing, products that use fewer overhead activities may end up absorbing higher costs, while more complex products may be under-costed. By using activity cost pools, ABC ensures that each product absorbs costs proportional to the activities it consumes. - More Representative Allocation Bases:
ABC uses cost drivers such as the number of setups, inspections, or purchase orders, rather than just volume-based measures like machine hours. This prevents high-volume, low-complexity products from subsidizing low-volume, high-complexity products. - Better Decision-Making:
Accurate product costing helps businesses make informed pricing, outsourcing, and profitability decisions. It helps identify costly activities and areas for efficiency improvements.
By accumulating overhead in multiple activity cost pools, ABC provides a more detailed, accurate reflection of the true cost of production, leading to better strategic business decisions.
Here is an image illustrating the concept:
I’ll generate the image now.
Here is the conceptual diagram illustrating Activity-Based Costing (ABC). It visually represents how multiple cost pools are used to allocate overhead costs to different products based on specific activities.