Question

What is the first step in applying activity-based costing? Why is overhead allocation under ABC usually more accurate than either the plantwide overhead allocation method or the departmental overhead allocation method? Why are direct labor hours and machine hours commonly used as the bases for overhead allocation?

Answer 1

The first step in activity-based costing is related to identifying key activities and classifying them according to the cost hierarchy.

ABC is usually more accurate because it uses multiple allocation basesand therefore allocates overhead more accurately. The result is that ABCoften charges low-volume products with more overhead than a traditional system.

Direct labor hours and machine hours are used by every department to which cost is allocated. This is the easiest method of allocating cost in best possible manner. It though lack accuracy of ABC costing.