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ACCA Strategic Professional · Strategic Business Leader · Cost and management accounting

Nordvik Components makes two products in one factory. Most overhead is machine set-up, inspection and material handling, which vary with the number of batches rather than units. Product A is made in large volumes in few batches; Product B is made in small volumes in many batches. Overheads are currently absorbed on direct labour hours. What is the most likely effect of moving to activity-based costing (ABC)?

Product A's cost falls and Product B's rises. Overheads are driven by batches, and B uses many more batches. ABC traces batch costs to the product causing them, whereas labour-hour absorption spreads them according to volume, which over-costs the high-volume product.

  1. AProduct A's reported cost rises and Product B's falls
  2. BProduct A's reported cost falls and Product B's risesCorrect
  3. CBoth products' reported costs fall because total overhead decreases
  4. DNeither product's cost changes because total overhead is unchanged

Explanation

Batch-related costs are driven by the number of batches. Product B uses many batches, so ABC assigns it more overhead. Product A, with few batches, was over-costed under labour hour absorption and now receives less. Total overhead is unchanged, but its allocation shifts, so the last option is wrong.

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