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Area I: Business AnalysisBusiness AnalysisCost Accounting

CPA · Question 05 · Area I: Business Analysis

A company produces two products, A and B. Under its traditional costing method, the company allocates overhead based on direct labor hours. Product A is a high-volume, simple product, while Product B is a low-volume, complex product. If the company switches to Activity-Based Costing (ABC), which of the following effects is MOST likely to occur?

Answer options:

A.

The reported cost of Product A will decrease, and the reported cost of Product B will increase.

B.

The reported cost of Product A will increase, and the reported cost of Product B will decrease.

C.

The total overhead costs allocated to both products will decrease.

D.

The gross margin for Product B will likely increase.

How to approach this question

Recall the 'cross-subsidization' concept. Traditional costing allocates overhead based on volume (labor hours), burdening high-volume products. ABC allocates based on activities. Complex, low-volume products consume more batch-level activities (setups) per unit. Therefore, ABC shifts cost FROM high-volume TO low-volume/complex products.

Full Answer

A.The reported cost of Product A will decrease, and the reported cost of Product B will increase.✓ Correct
A
Traditional costing allocates overhead based on volume (Direct Labor Hours). Product A (high volume) absorbs the bulk of the cost. Product B (complex) likely consumes more overhead activities (setups, orders) per unit than labor hours suggest. ABC corrects this by assigning these specific costs to B. Result: A's cost drops (was subsidizing B), B's cost rises.

Common mistakes

Thinking ABC reduces total costs (it just reallocates); confusing the direction of the shift.
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