Question

Which of the following statements describing a key reason for product cost differences between simple costing systems and ABC systems is true?

1) Simple costing systems allocate costs based on volume, while ABC systems allocate costs based on activities.
2) Simple costing systems allocate costs based on activities, while ABC systems allocate costs based on volume.
3) Simple costing systems allocate costs based on direct labor, while ABC systems allocate costs based on direct materials.
4) Simple costing systems allocate costs based on direct materials, while ABC systems allocate costs based on direct labor.

Answer 1

The true statement is that simple costing systems allocate costs based on volume, while ABC systems allocate costs based on activities, meaning option 1 is correct. The main difference lies in the way each system attributes indirect costs to products, with ABC systems providing a more nuanced approach.

Step-by-step explanation:

The key reason for product cost differences between simple costing systems and Activity-Based Costing (ABC) systems is that simple costing systems allocate costs based on volume, while ABC systems allocate costs based on activities. This is depicted in statement 1) which is true: Simple costing systems typically use a single, volume-based cost driver, such as machine hours or labor hours, to allocate indirect costs to products. In contrast, ABC systems use multiple cost drivers that are more closely related to the way in which activities consume resources to allocate indirect costs more accurately to products.

Understanding the distinction between these two systems is crucial because it affects the accuracy of product costing. Simple costing systems might oversimplify the cost allocation process and potentially misrepresent the actual cost of producing a product. In contrast, ABC systems strive to provide a more precise and nuanced view of cost allocation, by considering the specific activities that contribute to overhead costs.