Test 1: Activity Based Costing: answer key

Question 1 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Zenith Consumer Care Ltd manufactures two detergent powders, Fresh and Soft. The annual budget shows production and sales of 8,000 units of Fresh and 4,000 units of Soft. The following data are available: Product | Fresh | Soft Units | 8,000 | 4,000 Direct material per unit | ₹120 | ₹180 Direct labour per unit | ₹60 | ₹90 Machine hours per unit | 2 | 3 The company currently absorbs all production overheads of ₹8,40,000 on the basis of machine hours. Total budgeted machine hours are 28,000. Management is evaluating an Activity Based Costing system. The overheads have been grouped into three activity pools: Machine-related costs ₹5,60,000, driven by machine hours; Machine setup costs ₹1,40,000, driven by number of setups (Fresh 40, Soft 60); and Inspection costs ₹1,40,000, driven by inspection hours (Fresh 300, Soft 200). Production is carried out in batches; setups are required when switching between products. Inspection is performed on sampled batches. Machine-related costs include power, depreciation and maintenance and vary with machine hours. There is no opening or closing inventory. The company sells in a competitive market and suspects that high-volume Fresh is overcosted while low-volume Soft is undercosted by the traditional system. The pricing team uses unit product cost plus a mark-up, so accurate overhead allocation is important.

What is the machine setup activity rate per setup under ABC?

1. ₹1,200
2. ₹1,250
3. ₹1,400 (correct answer)
4. ₹1,500

Answer: C — ₹1,400

Explanation. Setup activity rate = Setup cost pool ÷ Total setups = ₹1,40,000 ÷ (40 + 60) = ₹1,40,000 ÷ 100 = ₹1,400 per setup. Option a arises if the pool is divided by 120, a common error of using machine hours instead of setups. Option b and d are simple miscalculations.

Where it goes wrong. Dividing the setup pool by machine hours or by total units instead of total setups.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 2 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the ABC overhead cost per unit of Fresh?

1. ₹57.50 (correct answer)
2. ₹60.00
3. ₹55.00
4. ₹62.50

Answer: A — ₹57.50

Explanation. Machine-related rate = ₹5,60,000 ÷ 28,000 = ₹20 per machine hour. Fresh uses 16,000 hours, so machine cost = ₹3,20,000. Setup cost = 40 × ₹1,400 = ₹56,000. Inspection rate = ₹1,40,000 ÷ 500 = ₹280; Fresh inspection = 300 × ₹280 = ₹84,000. Total Fresh overhead = ₹4,60,000; per unit = ₹4,60,000 ÷ 8,000 = ₹57.50. Option b is the traditional rate per unit, not ABC.

Where it goes wrong. Using the traditional machine-hour overhead rate of ₹30 instead of activity-specific rates.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 3 · 2 marks · Chapter 5: Activity Based Costing · medium

Compared with ABC, how is Soft costed under traditional absorption costing?

1. Overcosted by ₹5.00 per unit
2. Undercosted by ₹5.00 per unit (correct answer)
3. Overcosted by ₹2.50 per unit
4. Undercosted by ₹2.50 per unit

Answer: B — Undercosted by ₹5.00 per unit

Explanation. Traditional overhead rate = ₹8,40,000 ÷ 28,000 = ₹30 per machine hour. Soft traditional overhead = 3 × ₹30 = ₹90 per unit. ABC Soft overhead: machine 12,000 × ₹20 = ₹2,40,000; setup 60 × ₹1,400 = ₹84,000; inspection 200 × ₹280 = ₹56,000; total ₹3,80,000 ÷ 4,000 = ₹95. Thus traditional cost is lower by ₹5, meaning Soft is undercosted. Option c confuses the distortion of Fresh with Soft.

Where it goes wrong. Reversing the direction of cross-subsidisation between high-volume and low-volume products.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 4 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the total ABC overhead assigned to Soft?

1. ₹3,20,000
2. ₹4,60,000
3. ₹4,20,000
4. ₹3,80,000 (correct answer)

Answer: D — ₹3,80,000

Explanation. Soft receives machine-related cost 12,000 × ₹20 = ₹2,40,000; setup cost 60 × ₹1,400 = ₹84,000; inspection cost 200 × ₹280 = ₹56,000. Total = ₹2,40,000 + ₹84,000 + ₹56,000 = ₹3,80,000. Option a is Fresh machine cost only, and option b is total Fresh ABC overhead. Option c is a distractor from adding only two pools.

Where it goes wrong. Assigning the entire setup or inspection pool to one product instead of using actual driver consumption.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 5 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Nova Agri Foods Ltd sells packaged spices through three customer channels: Wholesalers, Supermarkets and Online Customers. The annual customer-level operating costs and cost drivers are: Activity | Cost (₹) | Cost driver Order processing | 9,60,000 | Number of sales orders Delivery | 24,00,000 | Kilometres travelled Customer visits | 12,00,000 | Number of customer visits Product handling | 8,40,000 | Quantity sold (kg) Channel-wise driver data are: Channel | Kg sold | Orders | Km travelled | Visits Wholesalers | 60,000 | 1,200 | 20,000 | 300 Supermarkets | 30,000 | 800 | 16,000 | 200 Online | 10,000 | 500 | 4,000 | 100 Total | 1,00,000 | 2,500 | 40,000 | 600 The listed selling price is ₹300 per kg for all channels. Discounts are: Wholesalers 10%, Supermarkets 12%, Online 15%. Cost of goods sold, excluding customer-level operating costs, is ₹180 per kg. The company wants to analyse channel profitability using ABC, as the traditional practice of applying a uniform percentage to sales revenue is suspected to distort profitability. Customer-level operating costs are assigned using the activity rates derived from the annual driver totals. All sales are in kg and there is no stock variation.

What is the customer visit cost incurred for the Wholesalers channel?

1. ₹5,40,000
2. ₹4,80,000
3. ₹6,00,000 (correct answer)
4. ₹6,60,000

Answer: C — ₹6,00,000

Explanation. Visit activity rate = ₹12,00,000 ÷ 600 visits = ₹2,000 per visit. Wholesalers visits = 300, so visit cost = 300 × ₹2,000 = ₹6,00,000. Option a uses 270 visits, which is a discount-related error; option b uses 240 visits. Option d results from applying ₹2,200 per visit.

Where it goes wrong. Using total channel kg or orders as the base instead of the actual number of visits.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 6 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the delivery cost for the Online channel?

1. ₹2,40,000 (correct answer)
2. ₹2,04,000
3. ₹2,64,000
4. ₹1,80,000

Answer: A — ₹2,40,000

Explanation. Delivery rate = ₹24,00,000 ÷ 40,000 km = ₹60 per km. Online km = 4,000, so delivery cost = 4,000 × ₹60 = ₹2,40,000. Option b uses ₹51 per km; option c uses ₹66 per km; option d uses 3,000 km. The trap is to use kg sold or orders as the delivery driver.

Where it goes wrong. Applying the delivery rate to kg sold rather than kilometres travelled.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 7 · 2 marks · Chapter 5: Activity Based Costing · medium

What is the total customer-level activity cost for the Supermarkets channel?

1. ₹1,872,000
2. ₹1,950,400
3. ₹1,884,800
4. ₹1,919,200 (correct answer)

Answer: D — ₹1,919,200

Explanation. Rates: order = ₹9,60,000 ÷ 2,500 = ₹384; delivery = ₹60/km; visit = ₹2,000; handling = ₹8.40/kg. Supermarkets cost = orders 800 × ₹384 = ₹3,07,200; delivery 16,000 × ₹60 = ₹9,60,000; visits 200 × ₹2,000 = ₹4,00,000; handling 30,000 × ₹8.40 = ₹2,52,000. Total = ₹19,19,200. Option a omits part of handling; option b uses 210 visits.

Where it goes wrong. Omitting one activity pool or using the wrong channel's visit count.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 8 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the customer-level operating income for the Online channel?

1. ₹28,000
2. ₹34,000 (correct answer)
3. ₹46,000
4. ₹52,000

Answer: B — ₹34,000

Explanation. Online gross revenue = 10,000 kg × ₹300 = ₹30,00,000. Discount 15% = ₹4,50,000; net revenue = ₹25,50,000. COGS = 10,000 × ₹180 = ₹18,00,000. Activity cost = order 500 × ₹384 = ₹1,92,000; delivery 4,000 × ₹60 = ₹2,40,000; visits 100 × ₹2,000 = ₹2,00,000; handling 10,000 × ₹8.40 = ₹84,000; total ₹7,16,000. Operating income = ₹25,50,000 − ₹18,00,000 − ₹7,16,000 = ₹34,000.

Where it goes wrong. Deducting discount from cost instead of from gross revenue, or omitting the 15% discount.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 9 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Arjun Precision Ltd manufactures two auto components, Alpha and Beta, in a single factory. Annual budgeted production is 5,000 units of Alpha and 2,500 units of Beta. The company has four activity cost pools: Activity pool | Budgeted cost (₹) | Driver | Alpha | Beta | Total Machine setups | 4,80,000 | Setups | 80 | 40 | 120 Inspection | 2,40,000 | Inspection hours | 300 | 100 | 400 Engineering | 3,60,000 | Engineering hours | 1,200 | 600 | 1,800 Plant occupancy | 5,40,000 | Machine hours | 20,000 | 10,000 | 30,000 Machine setup is a batch-level activity. Inspection is also performed batch-wise. Engineering support is a product-level activity. Plant occupancy includes factory rent, security, lighting and depreciation and is a facility-level activity. The plant occupancy cost pool is absorbed on budgeted machine hours. The practical capacity of the factory is 32,000 machine hours per annum, while the budget uses 30,000 machine hours. The company has recently introduced ABC to improve cost control and pricing. Management is also examining the cost of unused capacity, because the factory has spare machine capacity that is not currently used by either product. All overheads are annual and no work-in-progress or finished goods inventory exists. The company wants to identify activity rates, product-level overheads, unit overheads and the cost of unused capacity.

What is the setup cost per unit of Beta?

1. ₹64 (correct answer)
2. ₹48
3. ₹72
4. ₹80

Answer: A — ₹64

Explanation. Setup rate = ₹4,80,000 ÷ 120 setups = ₹4,000 per setup. Beta setup cost = 40 × ₹4,000 = ₹1,60,000. Beta units = 2,500, so setup cost per unit = ₹1,60,000 ÷ 2,500 = ₹64. Option b divides by total units; option c uses 45 setups; option d uses 50 setups.

Where it goes wrong. Dividing total setup cost by total units rather than Beta units.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 10 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the engineering activity cost assigned to Alpha?

1. ₹1,20,000
2. ₹1,80,000
3. ₹2,40,000 (correct answer)
4. ₹3,60,000

Answer: C — ₹2,40,000

Explanation. Engineering rate = ₹3,60,000 ÷ 1,800 engineering hours = ₹200 per hour. Alpha engineering hours = 1,200, so assigned cost = 1,200 × ₹200 = ₹2,40,000. Option a is Beta's engineering cost; option d is the entire pool; option b uses 900 hours.

Where it goes wrong. Assigning the whole product-level pool to one product instead of using engineering hours.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 11 · 2 marks · Chapter 5: Activity Based Costing · medium

What is the total ABC overhead cost per unit of Alpha?

1. ₹210
2. ₹230
3. ₹240
4. ₹220 (correct answer)

Answer: D — ₹220

Explanation. Rates: setup ₹4,000; inspection ₹2,40,000 ÷ 400 = ₹600; engineering ₹200; plant occupancy ₹5,40,000 ÷ 30,000 = ₹18 per machine hour. Alpha overhead = setups 80 × ₹4,000 = ₹3,20,000; inspection 300 × ₹600 = ₹1,80,000; engineering 1,200 × ₹200 = ₹2,40,000; occupancy 20,000 × ₹18 = ₹3,60,000. Total = ₹11,00,000 ÷ 5,000 units = ₹220.

Where it goes wrong. Using practical capacity of 32,000 hours for the absorption rate instead of budgeted 30,000 hours.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 12 · 2 marks · Chapter 5: Activity Based Costing · hard

What is the cost of unused capacity in the plant occupancy pool?

1. ₹18,000
2. ₹36,000 (correct answer)
3. ₹54,000
4. ₹72,000

Answer: B — ₹36,000

Explanation. Unused capacity = practical capacity − budgeted usage = 32,000 − 30,000 = 2,000 machine hours. Plant occupancy rate = ₹5,40,000 ÷ 30,000 = ₹18 per machine hour. Cost of unused capacity = 2,000 × ₹18 = ₹36,000. Option c uses 3,000 hours; option a uses half the correct amount; option d uses 4,000 hours.

Where it goes wrong. Computing unused capacity as total capacity minus actual product consumption without using the budgeted rate.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 13 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. A company absorbs overheads at ₹20 per direct labour hour. Product X uses 10,000 direct labour hours. Under ABC, the overhead attributable to Product X is ₹2,40,000. What is the cost distortion for Product X under traditional absorption costing?

A company absorbs overheads at ₹20 per direct labour hour. Product X uses 10,000 direct labour hours. Under ABC, the overhead attributable to Product X is ₹2,40,000. What is the cost distortion for Product X under traditional absorption costing?

1. Overcosted by ₹40,000
2. Undercosted by ₹20,000
3. Undercosted by ₹40,000 (correct answer)
4. Overcosted by ₹20,000

Answer: C — Undercosted by ₹40,000

Explanation. Traditional overhead = 10,000 hours × ₹20 = ₹2,00,000. ABC overhead = ₹2,40,000. Traditional costing assigns ₹40,000 less than ABC, so Product X is undercosted by ₹40,000. Option a reverses the direction; option b uses half the distortion. The distortion arises because a single volume base ignores activity consumption.

Where it goes wrong. Treating a lower traditional allocation as overcosting rather than undercosting.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 14 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. An activity cost pool is ₹6,72,000 and the total activity driver quantity is 16,800 machine setups. What is the activity cost driver rate?

An activity cost pool is ₹6,72,000 and the total activity driver quantity is 16,800 machine setups. What is the activity cost driver rate?

1. ₹40 per setup (correct answer)
2. ₹38 per setup
3. ₹42 per setup
4. ₹45 per setup

Answer: A — ₹40 per setup

Explanation. Activity cost driver rate = Total activity cost ÷ Activity driver = ₹6,72,000 ÷ 16,800 = ₹40 per setup. Option b arises from dividing by 17,684; option c from using ₹7,05,600; option d is a rounding error. The rate is used to assign activity costs to products based on setups consumed.

Where it goes wrong. Using total units produced or machine hours instead of actual setups in the denominator.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 15 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Which of the following is a batch-level activity under ABC?

Which of the following is a batch-level activity under ABC?

1. Electricity consumed by machines for each unit
2. Machine setup for a production batch (correct answer)
3. Designing a new product line
4. Factory security services

Answer: B — Machine setup for a production batch

Explanation. Batch-level activities are performed each time a batch is produced, such as machine setup, material ordering for a batch, or first-item inspection. Electricity for each unit is unit-level; product design is product-level; factory security is facility-level. Option b is the only activity that varies with batches rather than units, products or the entire facility.

Where it goes wrong. Confusing machine setup, which is batch-level, with machine operation, which is unit-level.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 16 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. Which term is defined as a measure of the frequency and intensity of demand placed on activities by cost objects?

Which term is defined as a measure of the frequency and intensity of demand placed on activities by cost objects?

1. Resource cost driver
2. Cost pool
3. Cost object
4. Activity cost driver (correct answer)

Answer: D — Activity cost driver

Explanation. An activity cost driver measures how frequently and intensely cost objects demand activities, and is used to assign activity costs to cost objects. A resource cost driver measures resources consumed by an activity. A cost pool is a group of costs with the same cause-and-effect relationship. A cost object is an item for which cost is measured. Option d matches the definition exactly.

Where it goes wrong. Confusing resource cost drivers with activity cost drivers.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 17 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. The order-processing activity rate is ₹450 per order. A customer places 36 orders during the year. What order-processing cost is assigned to this customer?

The order-processing activity rate is ₹450 per order. A customer places 36 orders during the year. What order-processing cost is assigned to this customer?

1. ₹15,000
2. ₹18,000
3. ₹16,200 (correct answer)
4. ₹14,400

Answer: C — ₹16,200

Explanation. Order-processing cost = Rate × Number of orders = ₹450 × 36 = ₹16,200. Option a uses 33.33 orders; option b uses 40 orders; option d uses 32 orders. In ABC, customer-level costs are assigned using actual or budgeted activity consumption, not sales value.

Where it goes wrong. Multiplying the rate by units sold or revenue instead of the number of purchase orders.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 18 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. An inspection activity has a budgeted cost of ₹8,00,000 for a capacity of 20,000 inspections. Actual inspections used are 17,500. What is the cost of unused capacity?

An inspection activity has a budgeted cost of ₹8,00,000 for a capacity of 20,000 inspections. Actual inspections used are 17,500. What is the cost of unused capacity?

1. ₹1,00,000 (correct answer)
2. ₹80,000
3. ₹1,20,000
4. ₹90,000

Answer: A — ₹1,00,000

Explanation. Inspection rate = ₹8,00,000 ÷ 20,000 = ₹40 per inspection. Unused capacity = 20,000 − 17,500 = 2,500 inspections. Cost of unused capacity = 2,500 × ₹40 = ₹1,00,000. Option b uses 2,000 inspections; option c uses 3,000; option d uses ₹36 per inspection.

Where it goes wrong. Using actual inspections instead of spare capacity in the unused-capacity calculation.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 19 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Which sequence correctly describes the main stages of installing an ABC system?

Which sequence correctly describes the main stages of installing an ABC system?

1. Calculate activity rates → identify activities → assign overheads to pools → assign costs to products
2. Identify activities → calculate activity rates → assign overheads to pools → assign costs to products
3. Assign overheads to pools → identify activities → assign costs to products → calculate rates
4. Identify activities → assign overheads to activity pools → determine activity cost drivers and rates → assign costs to products (correct answer)

Answer: D — Identify activities → assign overheads to activity pools → determine activity cost drivers and rates → assign costs to products

Explanation. The logical ABC sequence is: identify activities; relate overheads to activities to create cost pools using resource drivers; determine activity cost drivers and calculate activity rates; then assign activity costs to cost objects/products. Option b calculates rates before pools are formed; option a reverses identification and calculation; option c assigns product costs before computing rates.

Where it goes wrong. Calculating activity rates before the activity cost pools have been properly formed.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 20 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. What are the three key elements of Activity Based Budgeting (ABB)?

What are the three key elements of Activity Based Budgeting (ABB)?

1. Price, volume and profit
2. Type of work to be done, quantity of work to be done and cost of work to be done (correct answer)
3. Activity, cost driver and cost object
4. Planning, control and feedback

Answer: B — Type of work to be done, quantity of work to be done and cost of work to be done

Explanation. Activity Based Budgeting analyses resource inputs for each activity and requires the type of activity/work, the quantity of work, and the cost of work. These elements allow a cost-effective budget to be built for forecast workload. Option c lists ABC terms, not ABB elements. Option d is a general management cycle.

Where it goes wrong. Confusing ABB key elements with ABC terminology such as cost driver and cost object.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 21 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Which of the following is most likely a non-value-added activity?

Which of the following is most likely a non-value-added activity?

1. Polishing furniture before sale
2. Designing a product to customer specifications
3. Moving raw materials between storage and the production floor (correct answer)
4. Processing a customer order for dispatch

Answer: C — Moving raw materials between storage and the production floor

Explanation. Moving materials between storage and production is generally non-value-added because it does not improve the product's quality or function and customers do not pay for it. Polishing furniture, product design and order processing add value or are necessary to complete the customer's requirement. ABC and ABM identify such non-value-added activities for reduction or elimination.

Where it goes wrong. Treating all necessary activities as value-added; material movement is usually non-value-added.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 22 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. Pool A has a cost of ₹3,60,000 and 1,200 setups; Pool B has a cost of ₹5,40,000 and 18,000 inspections. Product M consumes 240 setups and 1,800 inspections. What overhead is assigned to Product M?

Pool A has a cost of ₹3,60,000 and 1,200 setups; Pool B has a cost of ₹5,40,000 and 18,000 inspections. Product M consumes 240 setups and 1,800 inspections. What overhead is assigned to Product M?

1. ₹1,26,000 (correct answer)
2. ₹1,20,000
3. ₹1,32,000
4. ₹1,08,000

Answer: A — ₹1,26,000

Explanation. Pool A rate = ₹3,60,000 ÷ 1,200 = ₹300 per setup. Pool B rate = ₹5,40,000 ÷ 18,000 = ₹30 per inspection. Product M cost = 240 × ₹300 + 1,800 × ₹30 = ₹72,000 + ₹54,000 = ₹1,26,000. Option b omits part of setup cost; option d uses 1,200 inspections.

Where it goes wrong. Applying a single average rate instead of separate activity rates for each pool.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 23 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. Which statement about ABC is correct?

Which statement about ABC is correct?

1. ABC eliminates all arbitrary cost allocations
2. ABC uses a single volume-based rate for all overheads
3. ABC is most suitable when overheads are low and products are homogeneous
4. ABC reduces cross-subsidisation by tracing overheads to activities consumed (correct answer)

Answer: D — ABC reduces cross-subsidisation by tracing overheads to activities consumed

Explanation. ABC assigns overheads to activities and then to products using activity consumption, which reduces cross-subsidisation between high-volume and low-volume products. It does not eliminate all arbitrary allocations, does not use a single volume rate, and is most useful when overheads are high and products are diverse. Option d correctly captures the main benefit.

Where it goes wrong. Believing ABC removes every allocation judgement; it improves traceability but still involves driver selection.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 24 · 2 marks · Chapter 5: Activity Based Costing · hard

Scenario. Which cost driver is most appropriate for purchasing department labour cost?

Which cost driver is most appropriate for purchasing department labour cost?

1. Direct labour hours
2. Number of purchase orders (correct answer)
3. Machine hours
4. Sales value

Answer: B — Number of purchase orders

Explanation. Purchasing department labour is driven by the number of purchase orders processed, so the number of purchase orders is the most appropriate activity cost driver. Direct labour hours and machine hours relate to production activities; sales value is a revenue measure and does not cause purchasing work. Using orders reflects the frequency and intensity of purchasing activity.

Where it goes wrong. Using a general volume measure such as direct labour hours instead of an activity-specific driver.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)

Question 25 · 2 marks · Chapter 5: Activity Based Costing · medium

Scenario. An activity-based budget provides ₹7,20,000 for machine setup activity at ₹120 per setup. How many setups are budgeted?

An activity-based budget provides ₹7,20,000 for machine setup activity at ₹120 per setup. How many setups are budgeted?

1. 5,000
2. 5,500
3. 6,000 (correct answer)
4. 6,500

Answer: C — 6,000

Explanation. Budgeted setups = Budgeted activity cost ÷ Rate per setup = ₹7,20,000 ÷ ₹120 = 6,000 setups. Option a uses ₹144 per setup; option b uses ₹131 per setup; option d uses ₹111 per setup. ABB reverses ABC: given cost and rate, the required activity quantity is derived for budgeting.

Where it goes wrong. Multiplying cost by rate instead of dividing cost by rate.

Authority. ICAI SM: Cost and Management Accounting, Chapter 5 (Activity Based Costing)