Under the absorption costing system, which simply allocates our entire amount of production overheads based on machine hours, we have found that out…

The company's current absorption costing system uses a single, volume-related cost driver (machine hours). This method inaccurately allocates overheads, especially when products have different complexities. Model B, despite low machine hours, is complex, requiring more production stages and expert customization. These activities generate significant overheads (e.g., setup, quality control, material handling) that are not driven by machine hours. Activity-Based Costing (ABC) would identify these activities and their true cost drivers. It would likely show that a large portion of overheads is unrelated to machine hours, and would reallocate these costs to Model B, revealing its true, and likely lower, profitability.

B. This states a potential consequence of implementing ABC, not the underlying reason why the current costing system is providing misleading information about Model B's profitability.

C. This statement is incorrect. Activity-Based Costing does not share overheads equally; it allocates them based on the consumption of specific activities, which is fundamentally different from an equal share.

1. Drury

C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. In Chapter 5

"Activity-Based Costing

" it is explained that traditional volume-based costing systems can report distorted costs. "Products that are produced in small batches and are complex in design will consume a high level of resources per unit... A traditional costing system that relies on a single volume-based overhead rate will understate the cost of these products" (p. 114). This directly supports the scenario where Model B's complexity is not captured by machine hours.

2. Kaplan

R. S.

& Cooper

R. (1988). Measure Costs Right: Make the Right Decisions. Harvard Business Review

66(5)

96-103. This foundational article on ABC highlights that as the diversity of products and production processes increases

overhead allocation based on a single driver like machine hours becomes increasingly inaccurate. The article argues that many overheads are related to transactions (like setups or purchase orders) and complexity

not volume

which explains why a complex product like Model B can be mis-costed.

3. CIMA. (2019). CIMA P2 Advanced Management Accounting Official Study Text. Kaplan Publishing. The chapter on Activity-Based Costing states that ABC "recognises that overhead costs are not all related to production and sales volume" and that it "traces overheads to products by identifying the cost drivers that cause the costs to be incurred." This principle directly validates that ABC would show that overheads are driven by more than just machine hours

as stated in option A.