How does activity-based costing improve product costing compared to traditional costing?

Activity-based costing (ABC) enhances product costing by allocating overhead costs based specifically on the activities that drive these costs, rather than simply averaging or spreading costs uniformly across all products. This method recognizes that different products use resources differently, which leads to a more precise representation of the actual costs associated with producing each product.

In traditional costing systems, overhead costs are often assigned based on a single metric, such as labor hours or machine hours, which can lead to distortions in product costing. By utilizing ABC, businesses can identify the various activities involved in the production process and how much each product contributes to these activities. This understanding allows for more accurate cost management and pricing decisions, as each product is assigned a cost that reflects its actual consumption of resources.

Consequently, adopting activity-based costing can lead to better strategic planning and operational efficiency, as it provides a clearer picture of which products are truly profitable and which may need adjustment or reevaluation.