How to approach it
- Traditional: total production overheads ÷ total direct labour (or machine) hours gives one rate; apply hours per unit.
- ABC: for each activity pool, rate = pool cost ÷ total driver quantity; charge each product its driver usage × rate.
- Divide each product's overhead by units produced (not sold) to get overhead per unit, then rebuild unit cost and profit on units sold.
- Compare and explain why the low-volume or complex product absorbs more under ABC.
Key rules to apply
- Volume-based rates spread batch- and product-level costs in proportion to volume, which under-costs low-volume, complex products.
- ABC traces overheads through cost drivers that reflect what causes the cost (set-ups, inspections, orders).
- Inventory is valued at production cost per unit; profit uses units sold.
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Dividing activity costs by units sold instead of units produced.
- Using one driver for all pools.
- Not explaining the difference between the two results when asked to comment.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q5 without copying it.
Original practice question
Traditional vs ABC overhead per unit
Two products: P (1,000 units, 2 labour hours each) and Q (500 units, 2 labour hours each). Overheads ₹1,20,000: set-up costs ₹60,000 (P 5 set-ups, Q 15) and inspection costs ₹60,000 (P 10 inspections, Q 30). Traditionally overheads are absorbed on labour hours.
Required: Compare overhead per unit under both methods.
Worked solution
| Working | P | Q |
|---|---|---|
| Traditional: ₹1,20,000 ÷ 3,000 hours = ₹40/hour × 2 | ₹80 | ₹80 |
| Set-ups: ₹60,000 ÷ 20 = ₹3,000 each | ₹15,000 | ₹45,000 |
| Inspections: ₹60,000 ÷ 40 = ₹1,500 each | ₹15,000 | ₹45,000 |
| ABC total | ₹30,000 | ₹90,000 |
| ABC per unit | ₹30 | ₹180 |
Answer: P falls from ₹80 to ₹30 per unit and Q rises from ₹80 to ₹180: Q drives most set-ups and inspections despite its lower volume.