Activity-Based Costing Exam Training
Exam questions on activity-based costing usually ask you to cost the same products two ways: with one plantwide overhead rate and with ABC. Comparing the answers shows which products were undercosted or overcosted. These notes give exam-focused practice on that skill.
What you will learn
- How to cost products with a single plantwide overhead rate
- How to cost the same products with activity-based costing
- How to spot undercosted and overcosted products
- Why low-volume, complex products often look cheaper than they are
The formulas
- Allocation base
- one measure for all overhead, e.g. machine hours or direct labor hours
- Cost pool total
- overhead cost of one activity
- Cost driver
- the measure of that activity, e.g. setups
Worked example
Overhead is $120,000 for setups (60 setups) and $300,000 for machining (15,000 machine hours). Product X: 1,000 units, 40 setups, 5,000 hours. Product Y: 4,000 units, 20 setups, 10,000 hours. Compare overhead per unit under a machine-hour plantwide rate and under ABC.
- Plantwide rate = $420,000 ÷ 15,000 hours = $28 per hour.
- Traditional: X = 5,000 × $28 ÷ 1,000 = $140; Y = 10,000 × $28 ÷ 4,000 = $70 per unit.
- ABC rates: setups = $120,000 ÷ 60 = $2,000; machining = $300,000 ÷ 15,000 = $20 per hour.
- ABC: X = (40 × $2,000 + 5,000 × $20) ÷ 1,000 = $180 per unit.
- ABC: Y = (20 × $2,000 + 10,000 × $20) ÷ 4,000 = $60 per unit.
Answer: Under ABC, X costs $180 per unit (not $140) and Y costs $60 (not $70). The traditional rate undercosts low-volume X by $40 and overcosts high-volume Y by $10.
Common questions
What is the difference between activity-based costing and traditional costing?
Traditional costing spreads all overhead with one rate based on a single measure like labor or machine hours. Activity-based costing splits overhead into activity pools, each with its own cost driver and rate, so products are charged for the activities they really use.
Which products are undercosted under traditional costing?
Usually low-volume, complex products that need lots of setups, inspections or special handling. A volume-based rate ignores those activities, so these products get too little overhead while high-volume, simple products get too much.
How do you solve an activity-based costing problem on an exam?
List each cost pool and its driver, compute an activity rate for each, multiply each rate by the driver quantity each product uses, add the pools up per product, then divide by units. If asked, repeat with a plantwide rate and compare.
Does activity-based costing change total overhead?
No. Total overhead stays the same under both methods. ABC only changes how that total is divided between products, which is why one product's cost goes up when another's goes down.