Final answer:
Activity-Based Costing (ABC) allocates overhead costs based on the activities that generate them, offering better product cost information and helping with pricing and process improvements compared to traditional costing methods.
Step-by-step explanation:
Activity-Based Costing (ABC) is a methodology used to more accurately allocate overhead costs to products or services based on the activities that generate costs. With ABC, costs are assigned based on activities such as material handling, machine setup, or quality inspections, rather than just on volume or traditional cost drivers. This allocation provides better product cost information, aiding in pricing, product mix, and process improvement decisions.
Traditional costing methods often apply overhead uniformly across products, which can lead to mispricing and insufficient understanding of each product's profitability. ABC avoids this by recognizing that different products consume different resources and should therefore bear different portions of indirect costs. Lastly, by focusing on activities that drive costs, a firm can identify inefficient processes and target them for improvement.