Final answer:
Activity-Based Costing (ABC) improves accuracy compared to traditional costing systems by allocating costs based on activities rather than arbitrary cost drivers.
Step-by-step explanation:
The Activity-Based Costing (ABC) system improves accuracy compared to traditional costing systems by allocating costs based on activities rather than arbitrary cost drivers. In traditional costing systems, costs are allocated based on volume measures such as labor hours or machine hours. However, ABC considers the activities that consume resources and assigns costs accordingly.
For example, let's consider a company that produces two products: Product A and Product B. In a traditional costing system, if Product A requires more machine hours than Product B, it would be assigned higher overhead costs. However, using ABC, the company can identify the specific activities that drive costs, such as setups or inspections. It may turn out that Product B requires more setups or inspections, even though it requires fewer machine hours. As a result, ABC provides a more accurate depiction of the true costs associated with each product.
By allocating costs based on activities, ABC helps identify areas of waste and inefficiency that may go unnoticed in traditional costing systems. It provides a more detailed understanding of how resources are consumed, allowing companies to make informed decisions and improve their cost management.