Explain how allocation methods affect product cost and profit
Trace overhead reallocations through unit cost, pricing and reported product profit without double counting total costs.
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
Selling price is $180 and allocated unit cost is $150. What is the product profit per unit before other stated costs?
What you will learn
- Calculate the effect of overhead allocation changes on unit cost
- Explain the effect on product profit at stated selling prices
- Separate reported product profitability from total company profit
Trace costs into product profit
A change in the overhead method changes product cost and, at a fixed selling price, the product's reported gross profit or contribution after the allocated overhead. It can affect pricing, product mix and performance assessment.
The total overhead may be unchanged, so a reallocation alone does not change total profit for the business when total sales, costs and inventory treatment are unchanged. Product profit changes are a distribution of the same cost across products.
Check inventory and decision context
If unsold inventory carries allocated production overhead, a different allocation can change closing inventory and reported profit between periods. Follow the question's inventory and costing assumptions rather than assuming all overhead is expensed immediately.
For decisions, distinguish full product cost from incremental or avoidable cost. A product with a high allocated fixed overhead may still contribute toward costs that would remain if it were discontinued.
Pause and explain
Why can product profit change without a change in total business profit?
Worked example
At a fixed price of $250, Product A's unit cost falls from $220 to $200 under ABC. Calculate unit profit under each method and the change.
Show the worked solution
- Traditional unit profit = $250 − $220 = $30.
- ABC unit profit = $250 − $200 = $50.
- Reported unit profit rises by $20 under the new allocation, but total overhead has not itself fallen.
Answer Product A's allocated-method profit rises from $30 to $50 per unit; total company overhead spending is unchanged by the reallocation.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
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.
A product sells for $120. Traditional cost is $100 per unit and ABC cost is $112. Calculate the change in product profit per unit.
Give me a hint
Calculate each selling-price less cost amount.
Compare my reasoning
- Traditional profit = $120 − $100 = $20.
- ABC profit = $120 − $112 = $8.
- The reported product profit falls by $12 per unit under ABC.
Product profit decreases from $20 to $8 per unit, a $12 change caused by allocation in this comparison.
Look for these in your work
- Calculate the traditional $20 result.
- Calculate the ABC $8 result.
- State the $12 per-unit allocation effect.
ABC reallocates $15,000 more overhead to Product R and $15,000 less to Product S. Total overhead is unchanged. State the direct product-cost and total-profit implications.
Give me a hint
The two product effects offset at the total overhead level.
Compare my reasoning
- R's total cost rises by $15,000 and S's falls by $15,000 before any inventory-timing effects.
- The product-level reported results change in opposite directions.
- Total business profit does not change solely from the reallocation if other amounts and inventory treatment are unchanged.
Product costs shift by $15,000 between R and S; the total overhead and, absent timing effects, total profit remain unchanged.
Look for these in your work
- Identify the cost increase for R.
- Identify the cost decrease for S.
- Separate product profit from total business profit.
A product appears loss-making after ABC, but discontinuing it would also reduce sales of a profitable complementary product. What analysis should the manager perform?
Give me a hint
Include incremental cost savings and effects on related sales, not just allocated overhead.
Compare my reasoning
- Estimate revenue and contribution lost from the product and its complementary sales.
- Identify avoidable costs and distinguish them from shared overhead that remains.
- Compare capacity use and alternatives for the resources before recommending continuation, redesign or closure.
Assess lost contribution from both products, avoidable costs, retained overhead and alternative capacity use before deciding.
Look for these in your work
- Include linked-product sales effects.
- Separate avoidable costs from overhead that remains.
- Compare alternative uses of capacity.
Common mistakes
- Claiming company profit rises when overhead is only reallocated
- Treating an allocated fixed cost as avoidable
- Ignoring unsold inventory and period timing
What can you explain now?
If product overhead falls under ABC but total overhead is unchanged, what is the direct conclusion?
Compare with the explanation
Product allocation changed, not total overhead spending
A different distribution of cost does not by itself reduce total overhead.
After trying it yourself, choose your next review. This is your self-assessment.
Your review choice appears on Today. Sign in to sync it across devices.
Make it stick
Explain the difference between product-level profit changes from allocation and a change in total company profit.
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.