Test 2: Activity Based Costing: answer key

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

Scenario. Apex Polychem Ltd manufactures two products: Industrial Resin (IR) and Specialty Coating (SC). Annual production is 20,000 units of IR and 10,000 units of SC. The company uses an Activity Based Costing system. Overhead costs and activity drivers are: Activity | Cost (₹) | Driver | IR | SC | Total Machine operation | 8,00,000 | Machine hours | 2 hr/unit | 4 hr/unit | 80,000 hours Setup | 3,00,000 | Number of setups | 50 | 100 | 150 Inspection | 2,00,000 | Inspection hours | 200 | 300 | 500 Product design | 1,50,000 | Engineering change orders | 10 | 20 | 30 Plant security | 1,00,000 | Facility-sustaining | — | — | — Machine operation is a unit-level activity. Setup and inspection are batch-level activities. Product design is a product-sustaining activity. Plant security is a facility-sustaining activity. The company is analysing cost behaviour and product profitability. All overheads are annual and there is no work-in-progress or finished goods inventory. The management wants to understand the cost hierarchy and assign costs to products using appropriate drivers.

Which of the following activities is classified as a facility-sustaining activity?

1. Machine operation
2. Setup
3. Product design
4. Plant security (correct answer)

Answer: D — Plant security

Explanation. Plant security is a facility-sustaining activity because it is necessary to sustain the manufacturing process but cannot be directly attributed to individual products. Machine operation is unit-level, setup is batch-level, and product design is product-sustaining. Facility-sustaining costs are common and joint to all products.

Where it goes wrong. Students may confuse plant security with a unit or batch-level activity because it is incurred regularly.

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 setup cost driver rate per setup?

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

Answer: B — ₹2,000

Explanation. Setup cost driver rate = Total setup cost ÷ Total setups = ₹3,00,000 ÷ 150 = ₹2,000 per setup. Option a uses 200 setups, option c uses 120 setups, and option d uses 100 setups. The rate is used to assign setup costs to products based on the number of setups each consumes.

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

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

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

What is the total product-sustaining cost assigned to Specialty Coating (SC)?

1. ₹50,000
2. ₹75,000
3. ₹1,00,000 (correct answer)
4. ₹1,50,000

Answer: C — ₹1,00,000

Explanation. Product design cost driver rate = ₹1,50,000 ÷ 30 ECOs = ₹5,000 per ECO. SC consumes 20 ECOs, so assigned cost = 20 × ₹5,000 = ₹1,00,000. Option a uses 10 ECOs, option b uses 15 ECOs, and option d is the total product design pool. Product-sustaining costs are assigned to products based on their consumption of the sustaining activity.

Where it goes wrong. Assigning the entire product design cost to one product or dividing equally between 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 unit-level overhead cost per unit of Industrial Resin (IR)?

1. ₹10
2. ₹20 (correct answer)
3. ₹30
4. ₹40

Answer: B — ₹20

Explanation. Machine operation rate = ₹8,00,000 ÷ 80,000 machine hours = ₹10 per hour. IR machine hours = 20,000 units × 2 hours = 40,000 hours. Unit-level overhead for IR = 40,000 × ₹10 = ₹4,00,000. Per unit = ₹4,00,000 ÷ 20,000 units = ₹20. Option a is the rate per hour, not per unit. Option c and d result from using wrong hours.

Where it goes wrong. Using the rate per machine hour as the per-unit cost, or multiplying by the wrong number of hours.

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

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

Scenario. Vikram Steels Ltd produces two grades of steel rods: Standard and Premium. Annual production is 12,000 units of Standard and 6,000 units of Premium. The company has identified the following activities and cost pools: Activity | Cost (₹) | Driver | Standard | Premium | Total Cutting | 4,80,000 | Machine hours | 1 hr/unit | 2 hr/unit | 24,000 hours Material handling | 2,00,000 | Number of material moves | 80 | 120 | 200 Production scheduling | 1,20,000 | Number of batches | 20 | 40 | 60 Product advertising | 2,00,000 | Directly traced | 80,000 | 1,20,000 | 2,00,000 Factory rent | 3,00,000 | Facility-sustaining | — | — | — Cutting is a unit-level activity. Material handling and production scheduling are batch-level activities. Product advertising is a product-sustaining activity, and the cost is directly traceable to each product line. Factory rent is a facility-sustaining activity. The company is considering ABC to improve cost control and pricing decisions. There is no opening or closing stock. Management wants to classify activities by hierarchy and compute activity rates and product costs.

Which of the following activities is a batch-level activity?

1. Cutting
2. Material handling (correct answer)
3. Product advertising
4. Factory rent

Answer: B — Material handling

Explanation. Material handling is performed for each batch and its cost varies with the number of material moves, making it batch-level. Cutting is unit-level because it varies with machine hours per unit. Product advertising is product-sustaining, and factory rent is facility-sustaining. Batch-level activities are performed each time a batch is processed.

Where it goes wrong. Classifying material handling as unit-level because it involves materials, or as facility-level because it supports the factory.

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 material handling cost per material move?

1. ₹800
2. ₹1,000 (correct answer)
3. ₹1,200
4. ₹1,500

Answer: B — ₹1,000

Explanation. Material handling rate = ₹2,00,000 ÷ 200 moves = ₹1,000 per move. Option a uses 250 moves, option c uses 166.67 moves, and option d uses 133.33 moves. This rate is used to assign material handling costs to products based on the number of moves each requires.

Where it goes wrong. Using the number of units or batches instead of the number of material moves in the denominator.

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 batch-level cost assigned to Premium?

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

Answer: C — ₹2,00,000

Explanation. Batch-level activities are material handling and production scheduling. Premium material handling = 120 moves × ₹1,000 = ₹1,20,000. Premium production scheduling = 40 batches × (₹1,20,000 ÷ 60) = 40 × ₹2,000 = ₹80,000. Total batch-level cost = ₹1,20,000 + ₹80,000 = ₹2,00,000. Option a is only material handling; option b omits one activity.

Where it goes wrong. Forgetting to include all batch-level activities or using the wrong driver quantities for Premium.

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

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

If facility-sustaining costs are allocated on the basis of total units produced, what is the facility-sustaining cost per unit?

1. ₹10.00
2. ₹12.50
3. ₹15.00
4. ₹16.67 (correct answer)

Answer: D — ₹16.67

Explanation. Total units = 12,000 + 6,000 = 18,000 units. Facility-sustaining cost per unit = ₹3,00,000 ÷ 18,000 = ₹16.67 per unit. Option a uses 30,000 units, option b uses 24,000 units, and option c uses 20,000 units. Facility-sustaining costs are not driven by volume, but if allocated on units, this is the rate.

Where it goes wrong. Using only one product's units or total machine hours instead of total units for allocation.

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

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

Scenario. Zenith Consumer Care Ltd manufactures two soap brands: Fresh and Soft. Annual production is 8,000 units of Fresh and 4,000 units of Soft. The following activity cost pools and drivers are available: Activity | Cost (₹) | Driver | Fresh | Soft | Total Mixing | 5,60,000 | Machine hours | 2 hr/unit | 3 hr/unit | 28,000 hours Packaging setup | 1,40,000 | Number of setups | 40 | 60 | 100 Quality inspection | 1,40,000 | Inspection hours | 300 | 200 | 500 Product formulation | 90,000 | Number of formulations | 5 | 10 | 15 Building depreciation | 1,50,000 | Facility-sustaining | — | — | — Mixing is a unit-level activity. Packaging setup and quality inspection are batch-level activities. Product formulation is a product-sustaining activity. Building depreciation is a facility-sustaining activity. The company is implementing ABC to analyse product costs and profitability. There is no inventory. The management wants to identify the cost hierarchy levels, compute activity rates, and assign overheads to products based on their consumption of activities.

How is 'Product formulation' classified in the cost hierarchy?

1. Unit-level activity
2. Batch-level activity
3. Product-sustaining activity (correct answer)
4. Facility-sustaining activity

Answer: C — Product-sustaining activity

Explanation. Product formulation is performed to support different products in the product line and is not related to the number of units or batches produced. It is a product-sustaining activity. Unit-level activities are performed for each unit, batch-level for each batch, and facility-sustaining for the entire facility. Product formulation benefits a specific product line.

Where it goes wrong. Confusing product formulation with unit-level or batch-level because it is part of production.

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 packaging setup cost per setup?

1. ₹1,200
2. ₹1,400 (correct answer)
3. ₹1,600
4. ₹1,800

Answer: B — ₹1,400

Explanation. Packaging setup rate = ₹1,40,000 ÷ 100 setups = ₹1,400 per setup. Option a uses 116.67 setups, option c uses 87.5 setups, and option d uses 77.78 setups. This rate is used to assign setup costs to Fresh and Soft based on their respective number of setups.

Where it goes wrong. Dividing the setup cost by total units or inspection hours instead of the number of setups.

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 batch-level cost for Fresh?

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

Answer: B — ₹1,40,000

Explanation. Batch-level activities are packaging setup and quality inspection. Fresh setup cost = 40 setups × ₹1,400 = ₹56,000. Fresh inspection cost = 300 hours × (₹1,40,000 ÷ 500) = 300 × ₹280 = ₹84,000. Total batch-level cost = ₹56,000 + ₹84,000 = ₹1,40,000. Option a is only inspection; option c adds mixing cost; option d is a miscalculation.

Where it goes wrong. Including unit-level or product-sustaining costs in the batch-level total, or omitting one batch-level activity.

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 unit-level overhead cost per unit for Soft?

1. ₹40
2. ₹50
3. ₹60 (correct answer)
4. ₹70

Answer: C — ₹60

Explanation. Unit-level activity is mixing only. Mixing rate = ₹5,60,000 ÷ 28,000 hours = ₹20 per hour. Soft machine hours = 4,000 units × 3 hours = 12,000 hours. Mixing cost for Soft = 12,000 × ₹20 = ₹2,40,000. Per unit = ₹2,40,000 ÷ 4,000 units = ₹60. Option a uses 2 hours per unit; option b uses ₹16.67 per hour; option d uses wrong hours.

Where it goes wrong. Including batch-level or product-sustaining costs in the unit-level cost, or using the total hours instead of Soft-specific hours.

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 has total setup cost of ₹5,00,000 and 250 setups. What is the setup cost driver rate?

A company has total setup cost of ₹5,00,000 and 250 setups. What is the setup cost driver rate?

1. ₹2,000 (correct answer)
2. ₹1,800
3. ₹2,200
4. ₹2,500

Answer: A — ₹2,000

Explanation. Setup cost driver rate = Total setup cost ÷ Number of setups = ₹5,00,000 ÷ 250 = ₹2,000 per setup. Option b uses 277.78 setups, option c uses 227.27 setups, and option d uses 200 setups. The rate is the basis for assigning setup costs to products in ABC.

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

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

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

Scenario. Which of the following is a product-sustaining activity?

Which of the following is a product-sustaining activity?

1. Designing a new product (correct answer)
2. Machine setup
3. Inspecting every unit
4. Plant security

Answer: A — Designing a new product

Explanation. Designing a new product is a product-sustaining activity because it supports a specific product line and is not related to the number of units or batches produced. Machine setup is batch-level, inspecting every unit is unit-level, and plant security is facility-sustaining. Product-sustaining costs are incurred to support individual products.

Where it goes wrong. Classifying product design as unit-level because it is done before production, or as facility-level because it benefits the whole company.

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

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

Scenario. A firm produces 10,000 units. Unit-level costs total ₹2,00,000. Batch-level costs total ₹1,00,000 for 50 batches. What is the total cost per unit if batch-level costs are allocated per unit?

A firm produces 10,000 units. Unit-level costs total ₹2,00,000. Batch-level costs total ₹1,00,000 for 50 batches. What is the total cost per unit if batch-level costs are allocated per unit?

1. ₹30 (correct answer)
2. ₹25
3. ₹35
4. ₹40

Answer: A — ₹30

Explanation. Unit-level cost per unit = ₹2,00,000 ÷ 10,000 = ₹20. Batch-level cost per unit = ₹1,00,000 ÷ 10,000 = ₹10. Total cost per unit = ₹20 + ₹10 = ₹30. Option b omits batch-level cost; option c adds an extra ₹5; option d uses wrong batch-level allocation. Batch-level costs are allocated per unit only for simplicity; in ABC they are assigned per batch.

Where it goes wrong. Allocating batch-level costs per batch instead of per unit when the question specifies per-unit allocation.

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

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

Scenario. Which cost hierarchy level includes costs that are fixed and cannot be traced to individual products?

Which cost hierarchy level includes costs that are fixed and cannot be traced to individual products?

1. Facility-sustaining (correct answer)
2. Unit-level
3. Batch-level
4. Product-sustaining

Answer: A — Facility-sustaining

Explanation. Facility-sustaining activities support the entire facility and are common and joint to all products, such as plant security, rent, and maintenance. These costs are fixed and cannot be traced to individual products. Unit-level, batch-level, and product-sustaining costs can be traced or allocated to products using appropriate drivers. Facility-sustaining costs are often allocated arbitrarily.

Where it goes wrong. Confusing facility-sustaining with product-sustaining because both are not unit-based.

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

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

Scenario. A company has inspection cost of ₹1,20,000. Inspection hours are 400 for Product A and 600 for Product B. What is the inspection cost per hour?

A company has inspection cost of ₹1,20,000. Inspection hours are 400 for Product A and 600 for Product B. What is the inspection cost per hour?

1. ₹120 (correct answer)
2. ₹100
3. ₹140
4. ₹150

Answer: A — ₹120

Explanation. Total inspection hours = 400 + 600 = 1,000 hours. Inspection cost per hour = ₹1,20,000 ÷ 1,000 = ₹120 per hour. Option b uses 1,200 hours, option c uses 857 hours, and option d uses 800 hours. This rate is used to assign inspection costs to products based on their inspection hours.

Where it goes wrong. Using only one product's hours or total units instead of total inspection hours.

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

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

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

Which of the following is a batch-level activity?

1. Machine setup (correct answer)
2. Direct material usage
3. Product advertising
4. Factory depreciation

Answer: A — Machine setup

Explanation. Machine setup is performed each time a batch is produced, so it is a batch-level activity. Direct material usage is unit-level, product advertising is product-sustaining, and factory depreciation is facility-sustaining. Batch-level costs vary with the number of batches, not with the number of units within the batch.

Where it goes wrong. Classifying machine setup as unit-level because it is part of production, or as facility-level because it involves machines.

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

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

Scenario. A company's facility-sustaining costs are ₹4,00,000. Total units produced are 20,000. If allocated on units, what is the facility cost per unit?

A company's facility-sustaining costs are ₹4,00,000. Total units produced are 20,000. If allocated on units, what is the facility cost per unit?

1. ₹15
2. ₹18
3. ₹20 (correct answer)
4. ₹25

Answer: C — ₹20

Explanation. Facility cost per unit = Total facility-sustaining cost ÷ Total units = ₹4,00,000 ÷ 20,000 = ₹20 per unit. Option a uses 26,667 units, option b uses 22,222 units, and option d uses 16,000 units. Facility-sustaining costs are not driven by volume, but this allocation may be used for inventory valuation.

Where it goes wrong. Using only the units of one product or total machine hours instead of total units.

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

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

Scenario. Cost driver for product-sustaining activities is typically:

Cost driver for product-sustaining activities is typically:

1. Number of units produced
2. Number of batches
3. Number of engineering change orders (correct answer)
4. Number of machine hours

Answer: C — Number of engineering change orders

Explanation. Product-sustaining activities are performed to support individual products, and a common cost driver is the number of engineering change orders or number of product designs. Number of units produced is a unit-level driver, number of batches is batch-level, and machine hours is unit-level. Product-sustaining costs are not driven by volume.

Where it goes wrong. Using a volume-based driver such as units or machine hours for product-sustaining costs.

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

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

Scenario. A company uses ABC. It has unit-level cost of ₹50 per unit, batch-level cost of ₹10,000 per batch, and produces 1,000 units in 5 batches. What is the total cost per unit?

A company uses ABC. It has unit-level cost of ₹50 per unit, batch-level cost of ₹10,000 per batch, and produces 1,000 units in 5 batches. What is the total cost per unit?

1. ₹80
2. ₹90
3. ₹100 (correct answer)
4. ₹110

Answer: C — ₹100

Explanation. Unit-level cost = 1,000 units × ₹50 = ₹50,000. Batch-level cost = 5 batches × ₹10,000 = ₹50,000. Total cost = ₹1,00,000. Cost per unit = ₹1,00,000 ÷ 1,000 = ₹100. Option a is unit-level only per unit? Actually ₹80 is ₹50 + ₹30, a common error of dividing batch cost by batches instead of units. Option b and d are miscalculations.

Where it goes wrong. Forgetting to multiply batch-level cost by number of batches, or dividing by number of batches instead of units.

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

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

Scenario. Which statement about cost hierarchy is correct?

Which statement about cost hierarchy is correct?

1. Unit-level costs vary with number of batches
2. Batch-level costs are fixed per unit
3. Product-sustaining costs are incurred for each unit
4. Facility-sustaining costs are not driven by volume (correct answer)

Answer: D — Facility-sustaining costs are not driven by volume

Explanation. Facility-sustaining costs support the entire facility and are not driven by production volume, batch numbers, or product variety. Unit-level costs vary with units, batch-level costs vary with batches, and product-sustaining costs vary with products. Option d is the only correct statement. The other options misclassify the cost behaviour.

Where it goes wrong. Believing batch-level costs are fixed per unit, when they are fixed per batch and vary per unit inversely with batch size.

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

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

Scenario. A company has setup cost of ₹90,000 for 150 setups. Product X requires 30 setups. What setup cost is assigned to Product X?

A company has setup cost of ₹90,000 for 150 setups. Product X requires 30 setups. What setup cost is assigned to Product X?

1. ₹15,000
2. ₹16,000
3. ₹20,000
4. ₹18,000 (correct answer)

Answer: D — ₹18,000

Explanation. Setup rate = ₹90,000 ÷ 150 = ₹600 per setup. Setup cost for X = 30 setups × ₹600 = ₹18,000. Option a uses 25 setups, option b uses 26.67 setups, and option c uses 33.33 setups. This illustrates how batch-level costs are assigned based on actual setup consumption.

Where it goes wrong. Dividing total setup cost by total units instead of multiplying the rate by X's setups.

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

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

Scenario. Which of the following is a facility-sustaining activity?

Which of the following is a facility-sustaining activity?

1. Machine maintenance
2. Product design
3. Material handling
4. Plant security (correct answer)

Answer: D — Plant security

Explanation. Plant security is a facility-sustaining activity because it supports the entire facility and cannot be traced to individual products. Machine maintenance can be unit-level or facility-level depending on context, but plant security is a classic example. Product design is product-sustaining, and material handling is batch-level. Facility-sustaining costs are common and joint.

Where it goes wrong. Classifying plant security as unit-level because it is incurred every day, or as batch-level because it supports production.

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

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

Scenario. In ABC, costs are grouped into cost pools based on:

In ABC, costs are grouped into cost pools based on:

1. Departments
2. Products
3. Customers
4. Activities (correct answer)

Answer: D — Activities

Explanation. Under Activity Based Costing, costs are grouped into cost pools based on activities that have the same cause-and-effect relationship, not by departments or products. This allows more accurate assignment of overheads to cost objects using activity drivers. Departments are used in traditional costing, while products and customers are cost objects.

Where it goes wrong. Confusing cost pools with cost objects or traditional departmental cost centres.

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