Compare ABC with traditional overhead absorption
Compare product costs under different allocation methods and explain why the total overhead can stay the same.
Section 4.1 · Activity based costing
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. Topic 4.1 covers activity-based costing (ABC), cost drivers, overhead apportionment and allocation, unit cost and selling-price calculations, method comparisons, uses and limitations, and supported decisions. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use AS Topic 2.1–2.2 knowledge of fixed and variable costs, overhead absorption, cost-plus pricing and contribution. This A Level pathway compares those methods with activity-based costing.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A $200,000 pool is absorbed over 10,000 machine hours. What is the rate?
What you will learn
- Calculate a traditional volume-based absorption rate
- Compare its product allocations with ABC
- Explain cost cross-subsidisation
Keep the total overhead separate from its distribution
A traditional method may divide total overhead by one base, such as machine hours, then charge products by their hours. ABC divides overhead into pools and applies a driver rate for each activity.
Both methods can allocate the same total overhead while assigning different amounts to each product. A high-volume product may be overcosted by a single volume base if it consumes fewer batch or support activities per unit; a low-volume complex product may be undercosted.
Compare assumptions and decision effects
Cross-subsidisation occurs when one product is charged too much overhead and another too little relative to their activity use. ABC can reveal this pattern when its drivers are valid, but traditional absorption may remain adequate if products use activities similarly. Compare the effects of the different overhead-absorption methods on product cost and profit.
Compare the cost shifts, product volumes, complexity and driver quality. Do not claim profit changes merely because the allocation changes; total overhead is unchanged unless the business changes actual activity or spending.
Pause and explain
If ABC reallocates overhead but total overhead spending is unchanged, what changes directly?
Worked example
A $308,000 overhead total is allocated over 5,000 machine hours. Products A and B use 2,000 and 3,000 hours. Calculate the traditional rate and allocations.
Show the worked solution
- Rate = $308,000 ÷ 5,000 = $61.60 per machine hour.
- A = 2,000 × $61.60 = $123,200.
- B = 3,000 × $61.60 = $184,800; together they equal $308,000.
Answer The rate is $61.60 per machine hour; A receives $123,200 and B $184,800.
Try a topic test
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Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Traditional overhead is $308,000 allocated over 5,000 machine hours. ABC assigns $104,000 to A and $204,000 to B. Compare A's allocation under traditional and ABC.
Give me a hint
Calculate A's traditional share first using its 2,000 machine hours.
Compare my reasoning
- Traditional rate = $308,000 ÷ 5,000 = $61.60 per hour.
- A traditional allocation = 2,000 × $61.60 = $123,200.
- ABC allocation is $104,000, which is $19,200 lower for A.
ABC charges Product A $19,200 less overhead than the traditional method; the total factory overhead remains $308,000.
Look for these in your work
- Calculate the traditional rate.
- Calculate A's $123,200 traditional allocation.
- Compare the $104,000 ABC allocation and preserve the total-cost distinction.
Product X has 1,000 units and is charged $40,000 traditional overhead; ABC charges it $32,000. Product Y has 200 units and charges change from $20,000 to $28,000. Calculate unit-overhead changes and interpret.
Give me a hint
Divide each product's overhead allocation by its output, then compare the direction.
Compare my reasoning
- X: traditional $40 per unit, ABC $32; reduction $8 per unit.
- Y: traditional $100 per unit, ABC $140; increase $40 per unit.
- ABC shifts overhead toward Y's activity use; verify drivers and compare total allocations before changing product prices.
ABC reduces X by $8 overhead per unit and increases Y by $40; validate the drivers and business effect before acting.
Look for these in your work
- Calculate X's per-unit overhead under both methods.
- Calculate Y's per-unit overhead under both methods.
- Explain the allocation shift without claiming total overhead changed.
A traditional method shows Product P is profitable and ABC shows a loss. The total overhead pool reconciles under both methods. What should management investigate before discontinuing P?
Give me a hint
Check activity driver accuracy and relevant costs, demand and contribution before making a product decision.
Compare my reasoning
- Validate the ABC driver counts and whether the activity pools reasonably reflect resources consumed.
- Separate allocated fixed overhead from avoidable costs and check contribution, capacity and demand effects.
- Assess whether redesign, batch changes or process improvements could change activity use and whether the product supports other sales.
The ABC loss is a signal for investigation, not an automatic closure decision. Check driver validity, avoidable costs, contribution, capacity and strategic effects.
Look for these in your work
- Validate drivers and pool assumptions.
- Identify avoidable costs and contribution.
- Check demand, capacity and product links.
Common mistakes
- Comparing unit cost when product volumes differ without normalising
- Saying ABC reduces total overhead by itself
- Ignoring whether a cost difference changes a decision
What can you explain now?
What can happen when a single volume base is used for products with different activity needs?
Compare with the explanation
Some products may be overcosted and others undercosted
The single rate may not reflect batch or support activity consumed by each product.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Explain why the total overhead can remain unchanged while product costs differ between ABC and traditional methods.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.