Which of the following best describes an activity-based approach to designing a costing system?

• A. Assigning all overhead costs equally to all products regardless of usage.
• B. Recording expenses only when cash is paid.
• C. Allocating costs to products based on the activities required to produce them.
• D. Recognizing revenue when goods are shipped to customers.

Answer: (C)

Verified step by step guidance

1. Understand the concept of an activity-based costing (ABC) system: This approach allocates overhead costs to products or services based on the specific activities required to produce them. It focuses on identifying cost drivers (e.g., machine hours, labor hours, or number of setups) that directly relate to the production process.
2. Analyze the options provided in the question: Each option describes a different approach to costing or accounting. Compare these options to the definition of activity-based costing.
3. Option 1: 'Assigning all overhead costs equally to all products regardless of usage' describes a traditional costing system, not an activity-based approach. Traditional systems often allocate costs using a single cost driver, such as direct labor hours, without considering the actual activities involved.
4. Option 2: 'Recording expenses only when cash is paid' refers to cash-basis accounting, which is unrelated to activity-based costing. This option does not align with the principles of ABC.
5. Option 4: 'Recognizing revenue when goods are shipped to customers' refers to revenue recognition principles, not costing systems. This is unrelated to the activity-based approach. Therefore, the correct answer is Option 3: 'Allocating costs to products based on the activities required to produce them,' as it aligns with the definition of activity-based costing.