Activity-based costing differs from traditional costing systems in a number of ways. In activity-based costing, non-manufacturing as well as manufacturing costs may be assigned to products. And, some manufacturing costs may be excluded from product costs.
The controller of Chicago Company is in charge of installing a new costing system that includes the allocation of indirect manufacturing costs to the producing departments. After studying the situation, he found there were three cost drivers that could be used to assign the indirect costs, each with its own merits. After computing the allocations for the departments on a sample month, he found that each cost driver favored (that is, assigned less costs to) a different department. Machine hours favored Department X, direct manufacturing labor hours favored Department Y, and number of processing steps performed favored Department Z.
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