ICAEW BIP · Chapter 2
Overheads, absorption and marginal costing MCQs with Answers
12 multiple-choice questions on Overheads, absorption and marginal costing for ICAEW BIP Business Insight and Performance. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Rawlings Ltd absorbs production overheads on a machine hour basis. Budgeted overheads were £486,000 and budgeted machine hours were 54,000. Actual overheads were £503,700 and actual machine hours were 55,800. What was the under- or over-absorption of overheads?
- A) £17,700 under-absorbed
- B) £1,500 over-absorbed
- C) £1,500 under-absorbed
- D) £16,200 over-absorbed
Show answer & explanation
Answer: C) £1,500 under-absorbed
Overhead absorption rate = £486,000 / 54,000 = £9.00 per machine hour. Overheads absorbed = 55,800 x £9.00 = £502,200. Actual overheads of £503,700 exceed the amount absorbed by £1,500, so overheads are under-absorbed.
Question 2
A factory has two production departments (X and Y) and two service departments. Maintenance costs £40,000 and provides 50% of its services to X, 40% to Y and 10% to the canteen. The canteen costs £30,000 before any reapportionment and serves X and Y in the ratio 60:40. It does no work for maintenance. Using the step-down method, starting with maintenance, what is the total service department cost reapportioned to department X?
- A) £38,000
- B) £42,000
- C) £40,222
- D) £40,400
Show answer & explanation
Answer: D) £40,400
Maintenance is reapportioned first: X £20,000, Y £16,000, canteen £4,000. The canteen total becomes £30,000 + £4,000 = £34,000, which is then shared 60:40, giving X £20,400. Total reapportioned to X = £20,000 + £20,400 = £40,400. The step-down method fully reflects maintenance's work for the canteen because the canteen does no work for maintenance.
Question 3
Which basis would normally be most appropriate for apportioning factory rent between production cost centres?
- A) Machine hours worked in each cost centre
- B) Number of employees in each cost centre
- C) Value of materials used in each cost centre
- D) Floor area occupied by each cost centre
Show answer & explanation
Answer: D) Floor area occupied by each cost centre
Overheads should be apportioned on a basis that reflects how each cost centre benefits from the cost. Rent relates to the space a cost centre occupies, so floor area is the most suitable basis. Employee numbers suit costs such as the canteen, and machine hours suit costs such as machine power.
Question 4
In its first period of trading, Bexley Ltd produced 24,000 units and sold 21,000 units. The fixed production overhead absorption rate was £6 per unit. Profit under marginal costing was £142,000. What was the profit under absorption costing?
- A) £124,000
- B) £286,000
- C) £160,000
- D) £268,000
Show answer & explanation
Answer: C) £160,000
Inventory increased by 24,000 - 21,000 = 3,000 units. Under absorption costing, 3,000 x £6 = £18,000 of fixed production overhead is carried forward in closing inventory instead of being charged against this period's profit. Absorption costing profit = £142,000 + £18,000 = £160,000.
Question 5
Product Q has the following unit data: Selling price £48 Direct materials £14 Direct labour £9 Variable production overhead £5 Variable selling cost £3 Fixed production overhead £7 What is the contribution per unit of product Q?
- A) £17
- B) £20
- C) £10
- D) £25
Show answer & explanation
Answer: A) £17
Contribution is selling price less all variable costs, including variable selling costs. £48 - (£14 + £9 + £5 + £3) = £17. Fixed production overhead is not deducted because under marginal costing it is treated as a period cost.
Question 6
Product R has the following unit costs: Direct materials £18 Direct labour £11 Variable production overhead £4 Fixed production overhead £9 Variable selling cost £2 At what cost per unit would closing inventory of product R be valued under absorption costing?
- A) £44
- B) £42
- C) £35
- D) £33
Show answer & explanation
Answer: B) £42
Absorption costing values inventory at full production cost: direct materials, direct labour, variable production overhead and fixed production overhead. £18 + £11 + £4 + £9 = £42. Selling costs are never included in inventory. £33 would be the marginal costing valuation.
Question 7
In a period when inventory levels fall, how will reported profit under absorption costing compare with reported profit under marginal costing?
- A) Absorption costing profit will be higher
- B) The comparison depends on whether overheads were under- or over-absorbed
- C) Absorption costing profit will be lower
- D) The two profits will be the same
Show answer & explanation
Answer: C) Absorption costing profit will be lower
When inventory falls, fixed production overhead carried forward from earlier periods in opening inventory is released into this period's cost of sales under absorption costing. Marginal costing charges only the current period's fixed overhead. Absorption costing profit is therefore lower, by the reduction in inventory units multiplied by the fixed overhead absorption rate.
Question 8
Which of the following is an argument in favour of using marginal costing for internal reporting?
- A) Fixed production overheads are carried forward to match them with future sales
- B) Inventory valuation complies with the requirements of IAS 2 Inventories
- C) It shows the full cost of each unit, which is needed for long-term pricing
- D) Profit cannot be increased simply by producing more units for inventory
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Answer: D) Profit cannot be increased simply by producing more units for inventory
Under marginal costing, fixed production overheads are written off in full in the period they are incurred, so building up inventory cannot defer them and increase profit. The other statements are arguments for absorption costing: IAS 2 requires inventory to include production overheads, absorption costing carries fixed overheads forward, and it provides a full unit cost.
Question 9
Stanway Ltd makes one product, which sells for £60. Variable production cost is £22 per unit. Budgeted fixed production overheads are £300,000 and budgeted production is 25,000 units, and overheads are absorbed per unit. Fixed selling costs are £40,000. There was no opening inventory. In the period, 26,000 units were made and 24,000 were sold. Actual fixed production overheads were £305,000. What was the profit under absorption costing?
- A) £584,000
- B) £591,000
- C) £577,000
- D) £567,000
Show answer & explanation
Answer: B) £591,000
Absorption rate = £300,000 / 25,000 = £12 per unit, so full production cost = £22 + £12 = £34. Overheads absorbed = 26,000 x £12 = £312,000, compared with actual overheads of £305,000, so they are over-absorbed by £7,000. Profit = sales £1,440,000 - cost of sales (24,000 x £34) £816,000 + over-absorption £7,000 - fixed selling costs £40,000 = £591,000. The marginal costing profit of £567,000 differs by the 2,000 units added to inventory x £12.
Question 10
A company uses activity-based costing. Set-up costs for the period are £84,000 and there are 120 set-ups. Product P is made in batches of 500 units, needs 18 set-ups in the period, and its output is 9,000 units. What is the set-up cost per unit of product P?
- A) £1.40
- B) £0.70
- C) £0.08
- D) £9.33
Show answer & explanation
Answer: A) £1.40
Cost driver rate = £84,000 / 120 set-ups = £700 per set-up. Set-up costs traced to product P = 18 x £700 = £12,600. Cost per unit = £12,600 / 9,000 = £1.40.
Question 11
Under activity-based costing, which of the following is most likely to be the cost driver for the costs of the purchasing department?
- A) The number of direct labour hours worked
- B) The number of units produced
- C) The number of purchase orders raised
- D) The value of sales invoices issued
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Answer: C) The number of purchase orders raised
A cost driver is the factor that causes the costs of an activity to change. Purchasing department costs are driven mainly by the number of orders processed, not by labour hours or output volume. Using volume-based drivers for such costs is the weakness of traditional absorption costing that ABC aims to overcome.
Question 12
Over-absorption of production overheads happens when:
- A) actual activity is lower than budgeted activity
- B) the overheads absorbed into production exceed the overheads actually incurred
- C) the overheads absorbed into production are less than the overheads actually incurred
- D) actual overheads exceed budgeted overheads
Show answer & explanation
Answer: B) the overheads absorbed into production exceed the overheads actually incurred
Over-absorption means more overhead has been charged to units of production (actual activity x predetermined rate) than was actually incurred. The surplus is credited to the statement of profit or loss. Actual overheads exceeding budget, or lower activity than budgeted, would each tend to cause under-absorption instead.