Practice questions
Original questions written by HomiLabs in the style of the exam, with answers and mark schemes. They are not
Cambridge past paper questions and have not been reviewed by Cambridge. Try each one before opening the answer.
Q1Cost drivers and ABC pricing · Core · Paper 4 style · 5 marksIttehad Steel Fabricators, Lahore, makes gates, railings and window grilles in batches. It is introducing activity based costing (ABC).
- (a) Explain what is meant by a cost driver. [1]
- (b) Suggest a suitable cost driver for each of the following activities.(i) setting up machines for a new batch(ii) buying materials from suppliers(iii) inspecting finished goods(iv) despatching goods to customers [4]
Show answer
- (a) The factor that causes the cost of an activity to be incurred, so that the cost changes with the level of that factor.
1 mark.
- (b) (i) number of set-ups (ii) number of purchase orders (iii) number of inspections (iv) number of despatches/deliveries
1 mark each.
Mehran Pharmaceuticals has identified the following activities for the coming year.Activity Cost $ Expected driver volumeMachine set-ups 84,000 120 set-upsQuality inspection 56,000 1,400 inspectionsMaterial handling 37,500 2,500 movements
- (a) Calculate the cost driver rate for each activity. [3]
- (b) Explain what is meant by a cost pool. [1]
Show answer
- (a) Machine set-ups $700 per set-up; quality inspection $40 per inspection; material handling $15 per movement
84,000 ÷ 120; 56,000 ÷ 1,400; 37,500 ÷ 2,500. 1 mark each.
- (b) The total of all the overhead costs caused by one activity, collected together before being charged to products using the cost driver rate.
1 mark.
A company uses these cost driver rates: $700 per set-up, $40 per inspection and $15 per material movement. Product K needs 18 set-ups, 260 inspections and 400 material movements to make 5,000 units.
- (a) Calculate the total overhead charged to product K using ABC. [3]
- (b) Calculate the overhead cost per unit of product K. [1]
Show answer
- (a) $29,000
18 × 700 = 12,600; 260 × 40 = 10,400; 400 × 15 = 6,000. 1 mark each.
- (b) $5.80
29,000 ÷ 5,000.
The purchasing department of Faisalabad Garments has annual costs of: staff salaries $38,000; stationery and postage $2,400; purchasing software $5,600. It expects to place 920 purchase orders in the year.
- (a) Calculate the cost driver rate for the purchasing activity. [2]
- (b) Calculate the purchasing cost charged to the hospital uniforms product line, which needed 140 purchase orders. [1]
- (c) Explain why the number of purchase orders is a more suitable basis than direct labour hours for charging purchasing costs. [1]
Show answer
- (a) $50 per purchase order
Cost pool 38,000 + 2,400 + 5,600 = 46,000; ÷ 920 orders. M1 A1.
- (b) $7,000
140 × 50.
- (c) Purchasing cost is caused by the number of orders placed, not by how long workers spend making the products.
1 mark.
A commercial bank in Lahore wants to find the cost of each service it provides to customers.
- (a) Suggest a suitable cost driver for each of the following activities in the bank.(i) processing loan applications(ii) operating cash machines (ATMs)(iii) handling customer complaints [3]
- (b) State one reason why activity based costing is useful to a service business such as a bank. [1]
Show answer
- (a) (i) number of loan applications (ii) number of ATM transactions/withdrawals (iii) number of complaints received
1 mark each.
- (b) Most of its costs are overheads, so ABC gives a more accurate cost of each service or customer, helping to set fees.
1 mark.
Al-Rawdah Printing, Riyadh, is pricing a job for a customer. Direct costs are $2,400. The job needs 2 press set-ups (rate $180 per set-up), 6 hours of design (rate $45 per design hour) and 3 deliveries (rate $60 per delivery).
- (a) Calculate the overhead charged to the job using activity based costing. [2]
- (b) Calculate the total cost of the job and the price charged using a mark-up of 30%. [2]
Show answer
- (a) $810
2 × 180 + 6 × 45 + 3 × 60 = 360 + 270 + 180. M1 A1.
- (b) Total cost $3,210; price $4,173.00
1 mark each.
The owner of a spice-grinding and packing business in Hyderabad has heard about activity based costing.
- (a) State two features of activity based costing. [2]
- (b) State two features of a business for which activity based costing is likely to be most useful. [2]
Show answer
- (a) Any two: overheads are collected in cost pools by activity; each pool has its own cost driver; costs are charged to products according to their use of each activity; recognises that some costs are driven by batches or complexity, not volume.
1 mark each.
- (b) Any two: overheads are a large part of total cost; many different products or services; products differ greatly in complexity, batch size or support needed; a competitive market where accurate prices matter.
1 mark each.
Medicare Tablets makes a vitamin product in batches of 250 packs. Each batch needs one set-up (rate $500) and two inspections (rate $40 each). Each pack needs 0.2 machine hours (rate $30 per hour).
- (a) Calculate the ABC overhead cost per unit. [3]
- (b) Explain why the batch-related overhead per unit would fall if batches of 500 units were made. [1]
Show answer
- (a) $8.32
Batch costs (500 + 2 × 40) ÷ 250 = 2.32; machine 0.2 × 30 = 6.00; total 8.32. 1 mark each.
- (b) Set-up and inspection costs are incurred per batch, so they are spread over more units.
1 mark.
Karachi Sweets makes boxes of mithai (20,000 boxes a year) and celebration cakes (6,000 cakes a year). Its overheads have been analysed as follows.Activity Cost $ Cost driver Mithai CakesBatch set-ups 45,000 Number of set-ups 40 110Quality checks 30,000 Number of checks 200 400Packing 27,000 Packing hours 1,500 1,200
- (a) Calculate the cost driver rate for each activity. [3]
- (b) Calculate the overhead cost per box of mithai and per cake. [4]
Show answer
- (a) Batch set-ups 45,000 ÷ 150 = $300 per set-up; Quality checks 30,000 ÷ 600 = $50 per check; Packing 27,000 ÷ 2,700 = $10 per packing hour
1 mark each rate.
- (b) Mithai: 40 × 300 + 200 × 50 + 1,500 × 10 = $37,000; ÷ 20,000 units = $1.85 per unitCakes: 110 × 300 + 400 × 50 + 1,200 × 10 = $65,000; ÷ 6,000 units = $10.83 per unit
1 mark each product total, 1 mark each cost per unit (to 2 decimal places).
Chiniot Woodcraft makes 4,000 chairs and 1,000 tables a year. Direct costs per unit are: chair materials $22, labour $15; table materials $95, labour $48. Each chair takes 0.5 machine hours and each table 2 machine hours. Overheads are:Activity Cost $ Cost driver Chairs TablesMachine operation 96,000 Machine hours 2,000 2,000Machine set-ups 36,000 Number of set-ups 20 40Order processing 18,000 Number of orders 100 50
- (a) Calculate the overhead cost per chair and per table using activity based costing. [4]
- (b) Calculate the total cost per chair and per table. [2]
- (c) Calculate the selling price of each product if the business adds a mark-up of 40% on total cost. [2]
Show answer
- (a) Machine operation 96,000 ÷ 4,000 = $24 per machine hour; Machine set-ups 36,000 ÷ 60 = $600 per set-up; Order processing 18,000 ÷ 150 = $120 per orderChairs: 2,000 × 24 + 20 × 600 + 100 × 120 = $72,000; ÷ 4,000 units = $18.00 per unitTables: 2,000 × 24 + 40 × 600 + 50 × 120 = $78,000; ÷ 1,000 units = $78.00 per unit
1 mark rates; 1 mark chairs total; 1 mark tables total; 1 mark per-unit figures.
- (b) Chair $55; table $221
Chair 22 + 15 + 18; table 95 + 48 + 78. 1 mark each.
- (c) Chair $77.00; table $309.40
Total cost × 1.4. 1 mark each.
Margalla Medical Centre, Islamabad, treats 6,000 outpatients and 1,200 day-surgery patients a year. It has analysed its support costs as follows.Activity Cost $ Cost driver Outpatient Day surgeryAdmissions 72,000 Number of admissions 6,000 1,200Theatre 240,000 Theatre hours 0 1,600Laboratory 54,000 Number of tests 4,500 1,500
- (a) Calculate the cost driver rate for each activity. [3]
- (b) Calculate the overhead cost per patient for each type of patient. [4]
Show answer
- (a) Admissions 72,000 ÷ 7,200 = $10 per admission; Theatre 240,000 ÷ 1,600 = $150 per theatre hour; Laboratory 54,000 ÷ 6,000 = $9 per test
1 mark each.
- (b) Outpatient: 6,000 × 10 + 0 × 150 + 4,500 × 9 = $100,500; ÷ 6,000 patients = $16.75 per patientDay surgery: 1,200 × 10 + 1,600 × 150 + 1,500 × 9 = $265,500; ÷ 1,200 patients = $221.25 per patient
1 mark each total, 1 mark each cost per patient.
Gulf Signs, Muscat, receives an order for 600 aluminium signs. Direct costs are $14.20 per sign. The order will need 3 set-ups, 12 inspections and 80 machine hours. ABC cost driver rates are $450 per set-up, $35 per inspection and $28 per machine hour.
- (a) Calculate the overhead cost of the order using activity based costing. [3]
- (b) Calculate the total cost of the order. [1]
- (c) Calculate the price to quote for the order, in total and per unit, using a mark-up of 25% on cost. Give the price per unit to the nearest cent. [2]
Show answer
- (a) $4,010
3 × 450 = 1,350; 12 × 35 = 420; 80 × 28 = 2,240. 1 mark each.
- (b) $12,530
600 × 14.20 = 8,520 + 4,010.
- (c) $15,662.50 in total; $26.10 per unit
M1 × 1.25; A1 both figures.
The set-up cost pool of Bolan Plastics is $63,000 and the cost driver rate is $350 per set-up. Product P used 48 set-ups. The total ABC overhead charged to product P was $41,300, made up of set-up costs, inspection costs at $25 per inspection, and machine-related costs of $15,000.
- (a) Calculate the number of set-ups expected in the year. [1]
- (b) Calculate the set-up cost charged to product P. [1]
- (c) Calculate the number of inspections used by product P. [3]
Show answer
- (a) 180
63,000 ÷ 350.
- (b) $16,800
48 × 350.
- (c) 380
Inspection cost = 41,300 − 16,800 − 15,000 = 9,500; ÷ $25 = 380. M1 M1 A1.
Sunrise Distributors, Peshawar, supplies two customers. Customer A is a supermarket chain; customer B is a group of small shops. Activity costs are $40 per order processed, $85 per delivery and $25 per return handled. Customer A Customer BRevenue $ 60,000 40,000Gross margin 25% 40%Orders 50 120Deliveries 50 100Returns 10 30
- (a) Calculate the total activity cost of serving each customer. [4]
- (b) Calculate the profit earned from each customer after activity costs. [2]
- (c) Suggest two actions the business could take to improve the profit from customer B. [2]
Show answer
- (a) Customer A $6,500; customer B $14,050
A: 2,000 + 4,250 + 250; B: 4,800 + 8,500 + 750. 2 marks each.
- (b) Customer A $8,500; customer B $1,950
A: 25% × 60,000 = 15,000 − 6,500; B: 40% × 40,000 = 16,000 − 14,050. 1 mark each.
- (c) Any two: set a minimum order size; charge for deliveries or for small orders; combine orders into fewer deliveries; reduce returns (better quality/packing); encourage online ordering.
1 mark each.
Nairobi Business College runs a full-time course (300 students) and a weekend course (600 students). Fees are $900 per full-time student and $260 per weekend student. Tutor costs are $280 and $110 per student respectively. Other costs are:Activity Cost $ Cost driver Full-time WeekendEnrolment 36,000 Number of enrolments 300 600Classrooms 180,000 Room hours 8,000 4,000Assessment 42,000 Scripts marked 2,400 1,800
- (a) Calculate the overhead cost per student for each course using activity based costing. [5]
- (b) Calculate the profit or loss per student for each course. [2]
Show answer
- (a) Enrolment 36,000 ÷ 900 = $40 per enrolment; Classrooms 180,000 ÷ 12,000 = $15 per room hour; Assessment 42,000 ÷ 4,200 = $10 per scriptFull-time: 300 × 40 + 8,000 × 15 + 2,400 × 10 = $156,000; ÷ 300 students = $520.00 per studentWeekend: 600 × 40 + 4,000 × 15 + 1,800 × 10 = $102,000; ÷ 600 students = $170.00 per student
1 mark each rate (3); 1 mark each cost per student (2).
- (b) Full-time $100 profit; weekend $20 loss
Full-time 900 − 280 − 520; weekend 260 − 110 − 170. 1 mark each.
Pine View Hotel, Murree, sold 9,000 standard room-nights and 2,000 suite room-nights last year. Its support costs were:Activity Cost $ Cost driver Standard SuiteHousekeeping 96,000 Cleaning hours 6,000 2,000Laundry 28,000 Kilograms washed 20,000 15,000Reception 18,000 Number of check-ins 2,800 800
- (a) Calculate the cost driver rate for each activity. [3]
- (b) Calculate the overhead cost per room-night for each type of room. [4]
Show answer
- (a) Housekeeping 96,000 ÷ 8,000 = $12 per cleaning hour; Laundry 28,000 ÷ 35,000 = $0.80 per kg; Reception 18,000 ÷ 3,600 = $5 per check-in
1 mark each.
- (b) Standard: 6,000 × 12 + 20,000 × 0.80 + 2,800 × 5 = $102,000; ÷ 9,000 room-nights = $11.33 per room-nightSuite: 2,000 × 12 + 15,000 × 0.80 + 800 × 5 = $40,000; ÷ 2,000 room-nights = $20.00 per room-night
1 mark each total; 1 mark each cost per room-night.
An online homeware retailer in Karachi has these activity cost rates: picking $0.40 per item, packing $1.20 per parcel, returns $3.50 per return, customer calls $2.00 per call. Monthly data: Small orders Large ordersParcels (orders) 20,000 2,500Items picked 20,000 20,000Returns 800 300Customer calls 3,000 1,500
- (a) Calculate the total monthly activity cost of small orders and of large orders. [4]
- (b) Calculate the activity cost per order for each type. [2]
- (c) The retailer currently adds a flat handling charge of $3 to every order. Explain why this is unfair. [2]
Show answer
- (a) Small $40,800; large $15,050
Small: 8,000 + 24,000 + 2,800 + 6,000; large: 8,000 + 3,000 + 1,050 + 3,000. 2 marks each.
- (b) Small $2.04; large $6.02
1 mark each.
- (c) Large orders cost about three times as much to handle as small orders, so small-order customers pay more than their cost and large-order customers pay less than their cost (cross-subsidy).
1 mark each point.
Shahrah Motors, Lahore, assembles 10,000 City motorcycles (1.5 machine hours each, direct cost $410) and 3,000 Sport motorcycles (3 machine hours each, direct cost $690) a year. Overheads:Activity Cost $ Cost driver City SportPurchasing 210,000 Number of purchase orders 1,200 1,800Engineering changes 96,000 Number of changes 8 24Assembly line 480,000 Machine hours 15,000 9,000
- (a) Calculate the ABC overhead cost per motorcycle for each model. [5]
- (b) Calculate the selling price of each model using a mark-up of 25% on total cost. [2]
Show answer
- (a) Purchasing 210,000 ÷ 3,000 = $70 per order; Engineering changes 96,000 ÷ 32 = $3,000 per change; Assembly line 480,000 ÷ 24,000 = $20 per machine hourCity: 1,200 × 70 + 8 × 3,000 + 15,000 × 20 = $408,000; ÷ 10,000 units = $40.80 per unitSport: 1,800 × 70 + 24 × 3,000 + 9,000 × 20 = $378,000; ÷ 3,000 units = $126.00 per unit
1 mark each rate (3); 1 mark each per-unit figure (2).
- (b) City $563.50; Sport $1,020.00
City (410 + 40.80) × 1.25; Sport (690 + 126.00) × 1.25. 1 mark each.
Lahore Leather makes 8,000 standard bags and 1,500 designer bags a year. Direct costs are $24.45 per standard bag and $89.60 per designer bag. Overheads are:Activity Cost $ Cost driver Standard DesignerDesign 60,000 Design hours 100 400Cutting set-ups 42,000 Number of set-ups 30 70Inspection 33,000 Number of inspections 900 600
- (a) Calculate the overhead cost per unit of each bag using activity based costing. [3]
- (b) Calculate the selling price of each bag needed to give a profit margin of 20% of selling price. [2]
- (c) A competitor sells a similar designer bag for $175. Advise Lahore Leather whether it should reduce the price of its designer bag to $175. Justify your answer. [3]
Show answer
- (a) Design 60,000 ÷ 500 = $120 per design hour; Cutting set-ups 42,000 ÷ 100 = $420 per set-up; Inspection 33,000 ÷ 1,500 = $22 per inspectionStandard: 100 × 120 + 30 × 420 + 900 × 22 = $44,400; ÷ 8,000 units = $5.55 per unitDesigner: 400 × 120 + 70 × 420 + 600 × 22 = $90,600; ÷ 1,500 units = $60.40 per unit
1 mark rates; 1 mark product totals; 1 mark per-unit figures.
- (b) Standard $37.50; designer $187.50
Total cost: standard 24.45 + 5.55 = 30.00; designer 89.60 + 60.40 = 150.00; divide by 0.8. 1 mark each.
- (c) At $175 the margin would fall to (175 − 150) ÷ 175 = 14.29%, still a profit of $25 per bag. For: keeps market share; ABC shows the true cost is $150, so the bag is still profitable. Against: lower margin; the brand may justify a higher price (quality, design); other customers may expect discounts. Decision e.g. match the price only if volumes rise, or keep $187.50 and stress quality.
1 mark revised margin/profit; 1 mark points for and against; 1 mark justified decision.
Penang Circuits makes three electronic modules. Annual data: X Y ZOutput (units) 10,000 5,000 2,000Selling price per unit $ 30 48 120Direct costs per unit $ 16 22 31Overheads:Activity Cost $ Cost driver X Y ZSet-ups 150,000 Number of set-ups 10 30 60Component handling 90,000 Components handled 6,000 9,000 15,000Testing 120,000 Test hours 500 700 1,200
- (a) Calculate the overhead cost per unit of each product using activity based costing. [4]
- (b) Calculate the profit or loss per unit of each product. [2]
- (c) Advise the directors what action they should take on product Z. Justify your answer. [2]
Show answer
- (a) Set-ups 150,000 ÷ 100 = $1,500 per set-up; Component handling 90,000 ÷ 30,000 = $3 per component; Testing 120,000 ÷ 2,400 = $50 per test hourX: 10 × 1,500 + 6,000 × 3 + 500 × 50 = $58,000; ÷ 10,000 units = $5.80 per unitY: 30 × 1,500 + 9,000 × 3 + 700 × 50 = $107,000; ÷ 5,000 units = $21.40 per unitZ: 60 × 1,500 + 15,000 × 3 + 1,200 × 50 = $195,000; ÷ 2,000 units = $97.50 per unit
1 mark rates; 1 mark each product (3).
- (b) X $8.20; Y $4.60; Z loss $8.50
Price − direct cost − ABC overhead. 2 marks all correct, 1 mark for two.
- (c) Z makes a loss of $8.50 per unit because it uses a large share of set-ups and testing for low output. Options: raise the price above $128.50 (break-even cost), make Z in larger batches to cut set-ups, or redesign to reduce testing. Before dropping Z, check which overheads would actually be saved and whether customers buy Z with X and Y. Decision: e.g. raise price/reduce set-ups rather than drop at once.
1 mark use of figures and action(s); 1 mark justified decision.
Swift Filters, Gujranwala, makes 24,000 oil filters a year in batches of 400. Each batch needs one machine set-up costing $600 and four inspections costing $45 each. Each filter costs $40 to make, and inventory holding costs are 15% a year of the average value held.
- (a) Calculate the batch-related cost per unit with the current batch size of 400 units. [2]
- (b) Calculate the batch-related cost per unit if the batch size is increased to 1,000 units. [2]
- (c) Calculate the net annual saving from the larger batch size, after allowing for higher inventory holding costs. [2]
- (d) Advise the managers whether to increase the batch size. Justify your answer. [2]
Show answer
- (a) $1.95
60 batches × (600 + 4 × 45) = 46,800; ÷ 24,000 = 1.95. M1 60 batches × 780; A1.
- (b) $0.78
24 batches × 780 = 18,720; ÷ 24,000. M1 A1.
- (c) $26,280
Saving 46,800 − 18,720 = 28,080; extra holding cost: average inventory rises by (1,000 − 400) ÷ 2 = 300 units × $40 × 15% = 1,800; net 26,280. M1 A1.
- (d) Yes on cost grounds: a large net saving. But larger batches mean more finished inventory, a risk of obsolescence, less flexibility to meet changing customer orders and more storage space. Decision: increase, perhaps to an intermediate size, if demand is steady.
1 mark point(s) using figures/qualitative; 1 mark decision.
Ravi Valves wants to win a contract to supply 3,000 valves a year at a market price of $64 each, with a profit margin of at least 10% of selling price. Direct costs are $41 per valve. Production uses 24 set-ups at $900 each, 300 inspections at $30 each and 1,500 machine hours at $20 per hour.
- (a) Calculate the current total cost per unit of the valve. [3]
- (b) Calculate the maximum cost per unit that allows a 10% margin at a price of $64. [1]
- (c) Calculate how many set-ups must be eliminated if the cost reduction is to come entirely from set-ups. [2]
- (d) Discuss whether this reduction is realistic. [2]
Show answer
- (a) $61.20
Overhead 24 × 900 + 300 × 30 + 1,500 × 20 = 60,600; ÷ 3,000 = 20.20; + 41 = 61.20. M1 M1 A1.
- (b) $57.60
64 × 90%.
- (c) 12 set-ups (from 24 to 12)
Required reduction (61.20 − 57.60) × 3,000 = 10,800; ÷ $900 = 12. M1 A1.
- (d) Halving set-ups means producing in batches twice as large, which increases inventory and holding costs and may not suit customer delivery schedules; set-up time might instead be cut by better tooling, or savings found in inspections.
1 mark each point.
Seaside Snacks, Gwadar, uses ABC. Product Z has annual revenue of $180,000 and direct costs of $102,000. ABC charges it with set-up costs $36,000, inspection costs $18,000 and facility costs $40,000 (factory rent and insurance, shared on floor area). If Z were discontinued, all its set-up and inspection costs would be saved, but the facility costs would not change.
- (a) Calculate the profit or loss of product Z using activity based costing. [2]
- (b) Calculate the effect on the company's total profit if product Z is discontinued. [3]
- (c) Advise the directors whether to discontinue product Z. Justify your answer. [3]
Show answer
- (a) Loss $16,000
180,000 − 102,000 − 36,000 − 18,000 − 40,000. M1 A1.
- (b) Profit falls by $24,000
Lost revenue 180,000; saved direct costs 102,000, set-ups 36,000 and inspections 18,000; facility costs continue. 180,000 − 156,000 = 24,000 reduction. M1 avoidable costs; M1 facility cost excluded; A1.
- (c) Do not discontinue on these figures: Z contributes $24,000 towards facility costs that would still be paid. Consider raising its price or reducing set-ups. Also consider whether the space could be used for a more profitable product and the effect on customers who buy other products.
1 mark use of the figure; 1 mark other factor; 1 mark decision.
Zamzam Bottling budgeted set-up costs of $120,000 for 200 set-ups and inspection costs of $60,000 for 1,500 inspections. Actual results were: 215 set-ups costing $126,500; 1,420 inspections costing $61,000.
- (a) Calculate the budgeted cost driver rate for each activity. [2]
- (b) Calculate the overhead absorbed and the amount over- or under-absorbed for each activity. [4]
- (c) Calculate the net effect on profit of the over- and under-absorption. [1]
- (d) Suggest one reason for the under-absorption of inspection costs. [1]
Show answer
- (a) Set-ups $600; inspections $40
1 mark each.
- (b) Set-ups: absorbed $129,000, over-absorbed $2,500. Inspections: absorbed $56,800, under-absorbed $4,200
215 × 600; 1,420 × 40. 1 mark each figure.
- (c) Net under-absorption $1,700, reducing profit
2,500 − 4,200.
- (d) Actual inspection costs were higher than budgeted (e.g. higher inspector wages) while fewer inspections were carried out than budgeted.
1 mark.
Kohinoor Paints sells 12,000 tins a year at $18 each to a hardware chain, delivered in 12 monthly deliveries. The chain now wants weekly deliveries (52 a year) with no change in total volume or price. ABC rates: delivery $140 per delivery; order processing $35 per order (one order per delivery); quality certificate $20 per delivery.
- (a) Calculate the annual activity cost of supplying the customer under the present arrangement. [2]
- (b) Calculate the annual activity cost if the customer's request is accepted. [2]
- (c) Calculate the increase in price per unit needed to keep the profit from this customer unchanged. [2]
- (d) Advise the company how to respond to the customer's request. [2]
Show answer
- (a) $2,340
12 deliveries × (140 + 35 + 20) = 12 × 195. M1 A1.
- (b) $10,140
52 × 195. M1 A1.
- (c) $0.65 per unit (price rises to $18.65)
Extra cost 7,800 ÷ 12,000 units. M1 A1.
- (d) Accept only if the price rises by about $0.65 a unit (or a delivery charge of $195 per extra delivery is made); otherwise profit falls by $7,800. Consider the value of keeping a large customer and whether deliveries can be combined with other customers' routes.
1 mark use of figures; 1 mark justified advice.
Quetta Woollens absorbs all its production overheads using a single rate per direct labour hour. The finance director suggests changing to activity based costing.
- (a) Explain two advantages of activity based costing compared with traditional absorption costing. [4]
- (b) State one limitation of activity based costing. [1]
Show answer
- (a) Any two explained: more accurate product costs because overheads are charged according to what causes them; better pricing decisions, avoiding over-pricing high-volume and under-pricing low-volume products; identifies costly activities that can be controlled or reduced; better information for decisions about products and customers.
1 mark each advantage, 1 mark each explanation.
- (b) Any one: expensive and time-consuming to set up and run; choice of cost drivers can be subjective; some costs (e.g. factory rent) have no clear driver and still have to be apportioned; still based on historical/budgeted data.
1 mark.
Sargodha Agro Tools makes Alpha (20,000 units, 1 direct labour hour each) and Beta (2,000 units, 2 direct labour hours each). Total overheads are $240,000, analysed as:Activity Cost $ Cost driver Alpha BetaSet-ups 100,000 Number of set-ups 10 40Order handling 60,000 Number of orders 50 100Machining 80,000 Machine hours 15,000 5,000
- (a) Calculate the overhead cost per unit of each product using a single absorption rate per direct labour hour. [2]
- (b) Calculate the overhead cost per unit of each product using activity based costing. [4]
- (c) Explain why the two methods give such different results. [2]
Show answer
- (a) Alpha $10.00; Beta $20.00
240,000 ÷ 24,000 hours = $10 per hour; Alpha 1 hour, Beta 2 hours. M1 A1.
- (b) Set-ups 100,000 ÷ 50 = $2,000 per set-up; Order handling 60,000 ÷ 150 = $400 per order; Machining 80,000 ÷ 20,000 = $4 per machine hourAlpha: 10 × 2,000 + 50 × 400 + 15,000 × 4 = $100,000; ÷ 20,000 units = $5.00 per unitBeta: 40 × 2,000 + 100 × 400 + 5,000 × 4 = $140,000; ÷ 2,000 units = $70.00 per unit
1 mark set-up and order rates; 1 mark machining rate; 1 mark each per-unit figure (2).
- (c) Beta is made in small batches with many set-ups and orders, but uses few labour hours. Absorption on labour hours ignores this, so Beta is under-costed and high-volume Alpha over-costed.
1 mark: low-volume/complex product uses more batch-level activities; 1 mark: labour hours do not reflect this.
Tulip Cosmetics produced 10,000 units of a face cream and sold 8,000 units in its first year. There was no opening inventory. Production overhead per unit is $12 under traditional absorption costing and $9 under activity based costing.
- (a) Calculate the overhead included in the closing inventory under each method. [2]
- (b) Explain the effect on reported profit for the year of using ABC instead of absorption costing. [2]
- (c) State when the two methods would give the same profit. [1]
Show answer
- (a) Absorption $24,000; ABC $18,000
Closing inventory 10,000 − 8,000 = 2,000 units; × $12 and × $9. 1 mark each.
- (b) Profit is $6,000 lower under ABC, because $3 less overhead per unit is carried forward in closing inventory, so more of the year's overhead is charged against this year's profit.
1 mark amount; 1 mark explanation.
- (c) When there is no change in the level of inventory (production equals sales), since total overhead charged is the same.
1 mark.
Spice Route, Karachi, sells 50,000 packs of ground spices (direct cost $2.00 each, 0.1 machine hours each) and 4,000 gift hampers (direct cost $30.00 each, 0.25 machine hours each). Overheads of $180,000 are currently absorbed on machine hours. An ABC analysis shows:Activity Cost $ Cost driver Packs HampersSet-ups 72,000 Number of set-ups 12 36Packaging design 48,000 Design hours 20 60Machining 60,000 Machine hours 5,000 1,000
- (a) Calculate the overhead cost per unit of each product using the current machine-hour rate. [1]
- (b) Calculate the overhead cost per unit of each product using activity based costing. [3]
- (c) Calculate the selling price of each product under each method, using a mark-up of 30% on total cost. [2]
- (d) Discuss the consequences for the business of continuing to price using the machine-hour rate. [2]
Show answer
- (a) Packs $3.00; hampers $7.50
180,000 ÷ 6,000 hours = $30; packs 0.1 hours, hampers 0.25 hours.
- (b) Set-ups 72,000 ÷ 48 = $1,500 per set-up; Packaging design 48,000 ÷ 80 = $600 per design hour; Machining 60,000 ÷ 6,000 = $10 per machine hourPacks: 12 × 1,500 + 20 × 600 + 5,000 × 10 = $80,000; ÷ 50,000 units = $1.60 per unitHampers: 36 × 1,500 + 60 × 600 + 1,000 × 10 = $100,000; ÷ 4,000 units = $25.00 per unit
1 mark rates; 1 mark each per-unit figure.
- (c) Machine-hour rate: packs $6.50, hampers $48.75. ABC: packs $4.68, hampers $71.50
1 mark each method.
- (d) Packs are over-priced ($6.50 against an ABC-based $4.68), so the business may lose sales of its main product to competitors. Hampers are under-priced ($48.75 against $71.50), so they may sell well but could be making a loss. Overall profit may fall and wrong products be promoted.
1 mark packs over-priced/lost sales; 1 mark hampers under-priced/possible losses.
Indus Packaging plc makes 40 product lines, from high-volume standard cartons to small custom orders that need special design and many machine set-ups. Overheads are 60% of total cost and are absorbed using a single direct labour hour rate. The company has recently lost two large contracts for standard cartons to competitors that charged lower prices, while custom orders have increased. A new ABC system would cost $45,000 to install.
- (a) Advise the directors whether they should replace absorption costing with activity based costing. Justify your answer. [6]
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- (a) For ABC: overheads are 60% of total cost, so how they are charged matters; the 40 product lines vary greatly in batch size and the custom orders need many set-ups and design hours, so labour-hour absorption is likely to distort costs; recent loss of high-volume contracts suggests these are over-priced; ABC would give better pricing and show which customers and products are profitable.Against ABC: the $45,000 system cost and staff time; drivers must be chosen and data collected continually; some costs (rent) still have to be apportioned; staff may resist change; benefits are not certain.Decision: introduce ABC (perhaps first in the custom-order area) because the potential to correct pricing outweighs the cost.
Up to 2 marks for points for; up to 2 marks for points against (in context); 1 mark use of case data; 1 mark justified decision.
