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ACCA Strategic Professional · Advanced Performance Management · Strategic management accounting

Orlin Components makes two products using activity-based costing. Product X is made in large batches and Product Y in small, complex batches. Under traditional absorption costing on machine hours, X was reported as highly profitable and Y as marginal. After an ABC review, the setup and inspection cost pools were allocated by number of batches. Which outcome is most likely, and what is the strategic implication?

Unit cost of Y is likely to rise and that of X to fall, because setup and inspection costs are driven by batches and Y uses many more per unit. Total overhead is unchanged, but pricing and product mix decisions made on the old machine-hour figures may have been misleading.

  1. ACost per unit of X rises and Y falls, so Y should be priced more cheaply
  2. BCost per unit of Y rises and X falls, so pricing and product mix decisions based on the old figures may have been misleadingCorrect
  3. CBoth costs remain unchanged because total overheads are unchanged
  4. DCost per unit of X rises because large batches use more setups

Explanation

Setup and inspection costs are driven by batch count, not machine hours. Y has many more batches per unit, so ABC assigns it more overhead, while X, with few batches, gets less. Total overhead is unchanged but its distribution changes, which can alter pricing and mix decisions. Large batches mean fewer setups per unit, so X's cost falls.

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