Question

Why is overhead allocation under ABC usually more accurate than either the plant-wide overhead allocation method or the departmental overhead allocation method?

Short answer

ABCs are much broader than single plant overhead rates because they are the highest cost pools.

Step-by-step solution

Meaning of Departmental Overhead Rate

The overhead rate for a department represents the amount of expected overhead for that department and the volume of activities taking place there. If the departmental costing approach technique is used, the normal cost allocation strategy multiplies a standard departmental overhead rate by the number of units of action spent.

Explaining the comparison between ABC and different overheads

In terms of recognizing overhead cost pools and designating overhead costs within each pool, employing ABC varies from utilizing different departmental rates. When using different departmental rates, each department's capacities as a cost pool and merchandise are given the overhead costs designated to each department employing a volume-based factor (such as direct work hours or machine hours). It often assumes that each division's volume-based factor and overhead expenditures are straightforwardly related.

On the other hand, ABC is aware that overhead expenses are more complicated. One activity cost pool, such as purchasing costs, could include expenses from multiple departments and be determined by a single cost driver (number of invoices). The focus of ABC is on the costs associated with the activities. Therefore, it might argue that ABC captures the complexity of overhead expenses more accurately and how they are applied to producing goods.