ACCA Performance Management (F5) Certification Practice Exam

What happens to overhead costs in absorption costing for high-volume products?

1. They are under-allocated

2. They are accurately allocated

3. They are over-allocated

4. They are ignored

The correct answer is: They are over-allocated

In absorption costing, all manufacturing costs, including both variable and fixed overheads, are allocated to the units produced. When a company produces high-volume products, the fixed overhead costs are spread over a larger number of units. As a result, the allocation per unit of fixed overhead is lower because the same total overhead costs are divided by a greater quantity of outputs. However, if the production volume exceeds the actual sales, it can lead to a situation where fixed overhead costs are over-allocated on a per-unit basis because total fixed costs remain constant regardless of the number of units produced. This means that the costs assigned to each unit may not accurately reflect what was truly consumed in relation to the actual sales volume. Consequently, it gives the illusion of lower per-unit costs than they might truly be, especially if not all units produced are sold in the same period. Hence, the situation where fixed overheads are allocated to high-volume products can often result in them being perceived as over-allocated, particularly if inventory levels build up as a result of producing more than what is sold. This can misrepresent the product's profitability when evaluating financial performance, making it critical to understand how overhead allocation impacts decision-making and financial reporting.