Final answer:
Activity based costing differs from traditional absorption costing in three main ways: it uses cost pooling based on activities, it applies multiple cost drivers for assigning overhead costs, and it provides enhanced cost visibility for different business activities.
Step-by-step explanation:
The three ways that activity based costing (ABC) differs from traditional absorption costing are:
- Cost Pooling: ABC pools costs based on activities that cause the cost to occur, rather than just a broad division between variable and fixed costs. This provides a more precise measure of the costs associated with specific activities within the production process.
- Multiple Cost Drivers: While traditional costing methods often use a single cost driver like machine hours or labor hours, ABC uses multiple cost drivers to assign overhead costs more accurately to products that require different levels of support activities.
- Enhanced Cost Visibility: ABC provides enhanced transparency in costing by focusing on individual activities and their cost drivers. It allows firms to better understand the costs involved in diverse processes, such as manufacturing cars versus producing software or providing services like haircuts or fast food.
These differences contribute to a more accurate and informative cost measurement that is useful for managerial decision-making, especially for firms with diverse processes and products.