ACCA Performance Management (F5) Certification Practice Exam

Traditional absorption costing tends to under-allocate overhead costs primarily to which type of product?

1. High volume products

2. Low volume products

3. Seasonal products

4. Newly introduced products

The correct answer is: Low volume products

Traditional absorption costing allocates overhead costs based on a predetermined overhead rate, often related to direct labor hours or machine hours. This approach can inadvertently result in the under-allocation of overhead costs to low volume products. Low volume products typically have fewer units produced, which means that the total overhead costs are spread over a smaller number of units. Since overhead is allocated based on production activity, each unit of a low volume product ends up bearing a disproportionately small share of the overhead costs, compared to high volume products. This discrepancy occurs because high volume products, being produced in larger quantities, can absorb more of the overhead costs effectively. Additionally, low volume products may not fully utilize the fixed costs associated with overhead, contributing to a situation where their cost per unit appears lower than reality. In contrast, the fixed overhead costs might be accumulating substantially from high volume products, thus diluting the overhead burden on those units. Understanding this allocation method is key for management to properly assess product profitability and make informed pricing and production decisions.