In an activity-based costing system, what should be used to
assign a department’s manufacturing overhead costs to products
produced in varying lot sizes?

(b) In an activity-based costing (ABC) system, the activities
which drive the manufacturing department’s overhead
costs would be analyzed. Overhead would then be allocated to
products based on the resources consumed in their production.
The effect of producing different products in different lot sizes is
that some products incur more setup costs than others; products
produced in small batches must be produced more often, and
thus require more setups to achieve a given level of output.
Therefore, setup costs bear a cause and effect relationship with
and should be assigned to each production batch (and then
spread over the units in the batch). However, setups are not the
only activities driving overhead costs. Other overhead cost drivers
identifiable in production systems may include materials handling,
engineering changes to products, and rework costs.
Therefore, manufacturing overhead should be assigned to products
based on multiple cause and effect relationships [answer
(b) is correct and answer (a) is incorrect]. Answers (c)
and (d) are incorrect because allocation via these methods would
wholly defeat the purpose of ABC, which is founded upon cause
and effect allocation of costs to products.