In activity-based costing, what determines how overhead is allocated to departments?

• A. Direct labor hours
• B. Activity drivers that reflect resource use by activities
• C. Random allocation
• D. Fixed amounts per department

Answer: (B)

In activity-based costing, overhead allocation to departments is driven by the use of activities, measured with activity drivers. Each activity consumes resources, and the costs are assigned to departments based on how much they use that activity, using a driver that reflects the resource consumption—such as the number of setups, the count of purchase orders, or the number of machine hours. This approach ties overhead to the actual work performed, making the allocation more accurate than traditional methods that rely on direct labor hours or fixed, department-wide allocations. While traditional methods apply a single rate or fixed amounts, activity-based costing uses specific drivers that causally relate to overhead costs, which is why the activity drivers are the determining factor.