Final answer:
An activity-based cost (ABC) driver allocates overhead based on specific activities and the resources they consume, rather than on traditional measures like direct labor or production volume. Option 3, which corresponds to resource demands/resource consumption, is the correct answer as it reflects the principle behind ABC costing.
Step-by-step explanation:
An activity-based cost (ABC) driver allocates factory overhead to products or services based on the resource demands/resource consumption of the firm's outputs. This method moves away from traditional cost drivers like direct labor hours or production volume, aiming instead to assign costs more accurately based on specific activities and processes that consume resources.
As a result, ABC allows businesses to gain a better understanding of which products or services are truly generating overhead costs and helps in enhancing cost efficiency.
A key aspect to consider is the distinction between variable costs and fixed costs. Variable costs, such as labor and raw materials, vary directly with output. On the contrary, fixed costs, like rent, remain constant regardless of production levels. The ABC system will use various cost drivers to assign both types of costs wherever relevant, rather than just relying on a simple output measure.