P1: Costing

Answer: A. A direct cost can be specifically identified with and traced to a particular cost unit or batch — raw materials used in that batch are a clear example. Factory manager salary, factory rent and general equipment depreciation are all indirect (overhead) costs because they cannot be attributed directly to a specific batch; they benefit all production and must be apportioned. The distinction between direct and indirect costs determines how costs are allocated to units in costing systems.

Answer: B. The overhead absorption rate (OAR) = budgeted overheads ÷ budgeted activity = £240,000 ÷ 30,000 = £8 per machine hour. The £6 figure would arise from using a different activity base — for example, 40,000 budgeted labour hours (£240,000 ÷ 40,000 = £6). The £4 figure results from dividing by a budgeted unit volume of 60,000, applying an incorrect base. The correct approach is always to divide budgeted overheads by the budgeted level of the chosen absorption base. £10 does not follow from the budgeted figures.

Answer: C. Overhead absorbed = 32,000 hours × £8 = £256,000. Actual overhead incurred = £252,000. Since absorbed (£256,000) exceeds actual (£252,000), the difference of £4,000 is over-absorbed. The £4,000 under-absorbed option has the correct amount but the wrong direction. The £16,000 figure compares absorbed overhead to budgeted overhead (30,000 × £8 = £240,000), which is the volume variance rather than the over/under-absorption. The £12,000 figure compares actual to budget.

Answer: D. When production exceeds sales, closing inventory is higher than opening inventory. Under absorption costing, some of the fixed overhead is carried forward in closing inventory, deferring that cost to a future period and increasing the current period's reported profit. Under marginal costing, all fixed overhead is charged to the period regardless of inventory levels, giving a lower profit. The difference equals the inventory increase in units multiplied by the fixed overhead per unit.

Answer: A. Environmental costing frameworks commonly mirror the cost of quality structure: environmental prevention costs (e.g. designing cleaner processes, staff environmental training), environmental appraisal or detection costs (e.g. environmental monitoring and testing), internal failure environmental costs (e.g. cost of treating and disposing of waste before it leaves the organisation), and external failure environmental costs (e.g. fines for breaches, cost of cleaning up pollution that has already been released, reputational damage). This parallel structure is deliberate — it lets the same conformance-versus-non-conformance logic used for quality costs be applied to environmental performance, rather than environmental costs being an entirely separate, unrelated concept, and it's a distinct framework from target costing's cost-gap terminology.

Answer: A. The cost of quality framework splits quality-related costs into four categories: prevention costs (spent to stop defects occurring in the first place — e.g. quality training, supplier vetting, process design), appraisal costs (spent checking whether output conforms to requirements — e.g. inspection and testing), internal failure costs (arising when defects are found before the product reaches the customer — e.g. rework, scrap), and external failure costs (arising when defects are found after the product reaches the customer — e.g. warranty claims, returns, reputational damage). The other groupings listed are genuine cost classifications used elsewhere in management accounting, but they are not the cost of quality categories.

Answer: C. Expected output = input − normal loss = 500 − (10% × 500) = 500 − 50 = 450 kg. Abnormal loss = expected output − actual output = 450 − 420 = 30 kg. The 80 kg figure is the total difference between input and actual output (500 − 420), which mistakes all process loss for abnormal loss rather than distinguishing between normal and abnormal. The normal loss (50 kg) is expected and not treated as abnormal; only the excess over expected represents the abnormal element. 45 kg takes 10% of the expected output rather than of the input, and 100 kg does not follow from the figures.

Answer: B. Separating quality costs into these categories lets management see conformance costs (prevention plus appraisal — money spent to get things right) against non-conformance costs (internal plus external failure — the cost of getting things wrong), which typically move in opposite directions: investing more in prevention tends to reduce failure costs over time. This visibility supports decisions about where additional quality spend is likely to be worthwhile, rather than leaving quality-related costs buried and untraceable within general overheads. It isn't merely an audit formality, quality costs are frequently material rather than negligible, and quality costing is a complementary tool alongside standard costing and variance analysis, not a replacement for it.

Answer: B. Expected output = 1,000 − (20% × 1,000) = 1,000 − 200 = 800 litres. Cost per litre of expected output = total input cost ÷ expected output = £8,000 ÷ 800 = £10.00. The £8.00 figure divides total cost by total input (1,000 litres), ignoring the normal loss. When there is no scrap value, the normal loss has no monetary value and its cost falls on the expected output, raising the cost per unit compared with the raw cost per input unit. £6.40 deducts 20% from the cost per litre of input, and £12.50 applies the 20% loss twice (£8,000 ÷ 640).

Answer: C. Job costing is used when each job is distinct and can be specifically costed — for example, in construction, bespoke engineering, printing and professional services. It accumulates costs against a unique job number. Identical continuous production suits process costing, fully automated production may use machine-hour absorption, and large identical batches suit batch costing. The defining characteristic of job costing is the individuality of each cost unit.

Answer: D. Occupied room-nights = 200 rooms × 30 nights × 75% = 4,500 room-nights. Cost per occupied room-night = £450,000 ÷ 4,500 = £100.00. The £75.00 figure uses total available room-nights (200 × 30 = 6,000), ignoring the occupancy rate. Service costing uses composite cost units that reflect both capacity and usage; the occupied room-night captures actual usage, making it the most relevant denominator for cost control. £60.00 and £90.00 do not follow from the room-night figures.

Answer: A. Cost per set-up = £72,000 ÷ 120 = £600. Set-up cost per batch of X = 3 × £600 = £1,800. Set-up cost per unit of X = £1,800 ÷ 500 units = £3.60. The £600 figure is the cost per set-up, not per unit. Under traditional absorption, set-up costs would be spread over all production using a volume-based rate, undercharging low-volume complex products. ABC correctly charges Product X for the 3 set-ups it actually requires. £1.44 and £0.60 do not follow from the set-up figures.

Answer: B. Life cycle costing accumulates all costs associated with a product from inception (research, design, development) through production, marketing and distribution to end-of-life and disposal. Traditional period costing charges costs in the period incurred, making it difficult to assess the total profitability of a product across its full life. Life cycle costing does not ignore phases or eliminate R&D — it specifically captures those early costs, which can be significant, and matches them against the revenues they ultimately generate.

Answer: C. The sales value method allocates joint costs in proportion to sales value at the split-off point. Total sales value = £80,000 + £40,000 = £120,000. X's share = £80,000 ÷ £120,000 = 2/3. Joint cost allocated to X = 2/3 × £60,000 = £40,000. The £30,000 figure would result from an equal split. The sales value method is widely used because it reflects the relative economic benefit each product derives from the joint process. £50,000 does not follow from the sales values.

Answer: D. Variable cost per unit = (£85,000 − £61,000) ÷ (10,000 − 6,000) = £24,000 ÷ 4,000 = £6. Fixed cost = £85,000 − (10,000 × £6) = £85,000 − £60,000 = £25,000. Total cost at 8,000 units = £25,000 + (8,000 × £6) = £25,000 + £48,000 = £73,000. £63,000, £77,000 and £80,000 do not follow from the £6 variable cost and £25,000 fixed cost. As a check, 8,000 units lies halfway between the two activity levels, and £73,000 lies halfway between the two totals. The high-low method uses only the highest and lowest activity levels to separate fixed and variable elements.

Answer: A. Depreciation of machinery is caused by the use and ownership of specific machines, so it should be apportioned based on the value (or machine hours used) of machinery in each cost centre. Number of employees suits costs such as canteen or HR services, floor area suits rent and rates, and purchase orders relate to procurement activity. The apportionment basis should reflect the cause-and-effect relationship between the cost and the cost centre.

Answer: C. Closing inventory increased by 2,000 units (8,000 produced − 6,000 sold). Under absorption costing, each unit in closing inventory carries £4 of fixed overhead that is deferred to a future period. Absorption profit = marginal profit + (inventory increase × fixed overhead per unit) = £30,000 + (2,000 × £4) = £30,000 + £8,000 = £38,000. When production exceeds sales, absorption costing reports higher profit because some fixed overhead cost is held in inventory rather than expensed. £22,000 moves the £8,000 in the wrong direction, and £62,000 adds the fixed overhead on all 8,000 units produced.

Answer: D. Expected output = 2,000 − (10% × 2,000) = 2,000 − 200 = 1,800 kg. Since actual output (1,900 kg) exceeds expected output (1,800 kg), there is an abnormal gain of 1,900 − 1,800 = 100 kg. Abnormal gain is the opposite of abnormal loss. It is credited to the process account at the standard cost per unit and effectively reduces the cost charged to normal output. The 200 kg is the normal loss, not the abnormal gain. 50 kg does not follow from the figures, and 1,900 kg is the actual output.

Answer: A. Equivalent units for conversion in closing WIP = 500 units × 60% = 300 equivalent units. Materials are 100% complete in WIP, so their equivalent units = 500, but the question asks only about conversion. The 500 figure treats WIP as fully complete (100%), ignoring the 60% completion. Equivalent units convert partially completed work into a notional number of fully completed units, allowing cost per unit to be calculated when different cost elements are at different stages of completion. 200 is the incomplete 40% (500 × 40%), and 450 does not follow from the figures.

Answer: B. If environmental costs are simply absorbed into overheads using a broad, volume-based basis, products or processes that are genuinely more environmentally costly to produce will appear artificially cheap, while cleaner products absorb more than their fair share — distorting pricing and product-mix decisions. Activity-based costing, which traces costs to the specific activities and cost drivers that actually cause them, is the technique most commonly recommended to make environmental costs visible and correctly attributed, rather than leaving them buried in a general overhead pool. This doesn't mean environmental costs are always trivial (the opposite concern is what makes hiding them a problem), and it doesn't mean the only fix is discontinuing the product — better costing information supports better decisions generally, including but not limited to a discontinuation decision.

Answer: C. A bottleneck is the constraining resource — the process or machine that restricts the maximum rate at which the whole system can generate output and therefore throughput. Throughput accounting focuses on maximising throughput through the bottleneck, because all other processes are paced by the bottleneck. Efficiency, cost and headcount are not the defining characteristics. Improving any non-bottleneck process does not increase the organisation's total throughput unless the bottleneck itself is addressed.

Answer: C. Because the defect was identified and corrected before the goods left the company — i.e. before any customer was affected — this is an internal failure cost: a cost arising from a failure to meet quality requirements that is caught internally. Prevention costs are incurred to stop defects arising in the first place (this rework happens after a defect has already occurred, so it isn't prevention). Appraisal cost would be the cost of the inspection that found the fault, not the cost of correcting it. External failure costs only arise once a defective item has reached the customer, which didn't happen here since the batch was caught and reworked before despatch.

Answer: A. Cost per component = £6,400 ÷ 800 = £8.00. Profit per component = selling price − cost per unit = £12.00 − £8.00 = £4.00. The £8.00 figure is the cost per unit, not the profit. Batch costing spreads the total batch cost over all units in the batch to derive a cost per unit; this is then compared with the selling price to determine profitability at the unit level. £3.20 and £4.80 do not follow from the figures.

Answer: D. Normal loss = 10% × 1,000 = 100 units. Expected output = 1,000 − 100 = 900 units. Scrap value of normal loss = 100 × £1 = £100. Net input cost = £10,000 − £100 = £9,900. Cost per unit of expected output = £9,900 ÷ 900 = £11.00. The £10.00 figure ignores the normal loss entirely. When normal loss has a scrap value, it is credited against the process cost, reducing the net cost charged to expected output and therefore the cost per unit. £9.89 and £10.11 do not follow from the figures.

Answer: A. Throughput per unit = selling price − material cost (truly variable cost) = £80 − £32 = £48. Return per factory hour = throughput per unit ÷ bottleneck hours per unit = £48 ÷ 2 = £24. Cost per factory hour = total factory costs ÷ total bottleneck hours = £240,000 ÷ 8,000 = £30. TPAR = return per factory hour ÷ cost per factory hour = £24 ÷ £30 = 0.80. A TPAR below 1.0 indicates the product is not generating sufficient throughput to cover factory costs through the bottleneck, and action is required. 1.60 uses throughput per unit instead of per bottleneck hour (£48 ÷ £30), and 1.20 does not follow from the figures.

Answer: B. Total fixed costs remain constant as volume increases within the relevant range, but because fixed cost per unit = total fixed cost ÷ number of units, the fixed cost per unit falls as more units are produced. This is the basis of economies of scale from fixed cost leverage. Variable cost per unit stays constant within the relevant range. Understanding this distinction is fundamental to cost-volume-profit analysis and to the comparison of absorption costing and marginal costing.

Answer: C. Target costing establishes a cost target (derived from the market price and required margin) before the product is designed, and product engineers then aim to design the product to meet that target. Up to 80–90% of a product's costs are locked in at the design stage, so influencing cost is far more effective before production begins than after. Target costing applies to both manufacturing and services, and is not limited to situations where margins are unachievable — it is a proactive costing tool used during new product development.

Answer: D. A passenger-kilometre (one passenger transported one kilometre) is the standard composite cost unit used in transport services, reflecting both the number of passengers and the distance carried. It allows the total cost of operating a route to be spread across a meaningful measure of service output. Law firms use billable hours, hospitals use cost per patient-day or treatment episode, and banks might use cost per transaction or account. The composite unit chosen should reflect the key output characteristic of the service.

Answer: A. A predetermined rate is set at the start of the period using budgeted data, so that product costs can be calculated as production occurs — enabling timely pricing, quotations and cost reports throughout the period rather than waiting until actual overhead is known at the end. It does not eliminate over/under-absorption (which arises precisely because the predetermined rate differs from actual); it is not required by accounting standards for product costing; and cost centres are still needed. Timeliness of product costing is the primary rationale.

Answer: B. A defining characteristic of digital products is that the marginal cost of producing an additional unit (an extra download or software licence) is effectively zero — there is no material, and distribution is almost costless. This creates a challenge for traditional cost-plus pricing because a zero marginal cost product would be priced at zero using marginal cost as the base. Instead, digital product pricing typically uses value-based, subscription or tiered approaches. Digital products can be sold internationally, vary widely in their production processes, and have very low, not high, material costs.

Answer: B. Staff training and supplier vetting are designed to reduce the likelihood of defects arising in the first place, which is the defining feature of prevention costs. Inspecting finished goods and testing production samples is about detecting whether output already produced conforms to requirements, which is the defining feature of appraisal costs — the checking happens after production, not before it, and doesn't itself stop a defect from occurring. The two categories are commonly confused, but the distinction is prevention (before defects occur) versus appraisal (checking after production, before despatch) versus failure costs (which only arise once a defect has actually been found, internally or externally).

Answer: A. Supervisor salary is a stepped fixed cost — it is fixed within a range of output (up to 500 units per supervisor) and then steps up each time another 500-unit threshold is crossed. For 1,800 units: 1,800 ÷ 500 = 3.6, requiring 4 supervisors (you cannot employ 0.6 of a supervisor). Total supervisor cost = 4 × £30,000 = £120,000. The £90,000 figure incorrectly uses only 3 supervisors, covering just 1,500 units. Stepped fixed costs must be modelled carefully in budgets to avoid understating costs near threshold boundaries. £108,000 treats the cost as variable (3.6 × £30,000), but part of a supervisor cannot be employed.

Answer: B. P1 share = P1 machine hours ÷ total machine hours = 6,000 ÷ (6,000 + 4,000) = 60%. P1 allocation = 60% × £40,000 = £24,000. The £20,000 figure would result from an equal (50/50) split. The apportionment basis should reflect the extent to which each production department uses the service department's services, and machine hours is an appropriate driver for a maintenance department that services production machinery. £16,000 is P2's 40% share.

Answer: C. Under the net realisable value method, the NRV of the by-product is credited to the process account, thereby reducing the net joint process cost that must be allocated between the main (joint) products. This is the most common treatment: the by-product's value offsets joint costs, giving a lower cost base for the main products. Ignoring the value would overstate main product costs, and adding it to main product cost would increase, not reduce, that cost. By-products are incidental outputs with relatively small value compared to joint products.

Answer: D. Because the spill has already left the organisation's premises and affected the external environment (the river) before being addressed, the resulting fine and clean-up costs are external failure environmental costs — the environmental consequence has reached beyond the organisation's own boundary, mirroring how an external failure quality cost only arises once a defect has reached the customer. Had the spill been contained and treated entirely on-site before release, the treatment cost would instead be an internal failure environmental cost. Prevention costs would be spending incurred before any incident to reduce the risk of it happening, and appraisal/detection costs relate to monitoring for environmental risks, neither of which describes costs triggered by an incident that has already occurred and escaped the site.

Answer: A. The relevant range is the range of activity (volume) within which the assumed cost behaviour is expected to be valid — where fixed costs genuinely stay fixed (no step changes) and variable costs genuinely vary proportionally. Beyond the relevant range, step increases in fixed costs or changes in variable cost efficiency may occur. Cost-volume-profit analysis and flexible budgets rely on cost behaviour assumptions that only apply within this range, not at extreme or unusual output levels.

Answer: B. Making environmental costs visible supports several genuine decisions: more accurate product costs and pricing, since products that generate disproportionate environmental costs are no longer subsidised by other products through a broad overhead allocation; better-informed decisions about process redesign or capital investment aimed at reducing environmental costs; and clearer accountability, since managers responsible for a process can be held to account for the environmental costs it generates. It isn't primarily a financial reporting or inventory valuation requirement, and simply measuring and reporting the costs doesn't by itself reduce environmental impact — that still requires the business to act on the improved information.

Answer: C. Direct raw materials are a classic variable cost — the total material cost increases in direct proportion to the number of units produced. Factory rent, the factory manager's salary and the annual insurance premium are fixed costs that do not change (within the relevant range) as production volume changes. The distinction between fixed and variable costs is fundamental to marginal costing, CVP analysis, and budgeting for different activity levels.

Answer: B. A cost unit should reflect the primary output of the service. For a haulage company, the output is both the weight carried and the distance covered, so tonne-kilometres (or kilogram-kilometres) combines both dimensions into a single composite unit that reflects the service provided. Cost per employee does not measure output, cost per invoice is an administrative measure, and cost per complaint is a quality measure, not an output unit. Appropriate cost units enable meaningful cost comparison across periods and between companies.

Answer: C. In a highly automated department, machine time is the dominant resource and the primary driver of overhead (power, maintenance, depreciation of machinery). Using a machine hour rate therefore more accurately reflects the overhead consumed by each product. A labour hour or labour cost rate is appropriate in a labour-intensive department. A units-produced rate assumes all products consume equal overhead per unit, regardless of complexity or time taken. The basis chosen should reflect the principal activity that drives overhead cost.

Answer: D. Joint costs incurred before the split-off are sunk — they have already been incurred regardless of what is done with the product after the split-off — so they are irrelevant to the further processing decision. The relevant comparison is the incremental revenue from processing further (incremental selling price minus split-off value) versus the incremental cost of further processing. Any positive incremental contribution justifies further processing. Including sunk joint costs distorts the decision and may lead to incorrectly rejecting profitable further processing.

Answer: D. Because the fault was only discovered after the goods had been sold and delivered to customers, the resulting warranty claims, returns processing, and any associated reputational damage are external failure costs — quality failures that reach and affect the customer. This is distinct from internal failure costs, which relate to defects caught and corrected before the goods leave the company. Prevention and appraisal costs relate to stopping defects occurring and checking for them respectively, neither of which describes costs incurred as a direct consequence of a fault already found by the customer.

Answer: B. DPP extends gross margin analysis by attributing additional direct costs — such as warehouse and shelf space, handling, refrigeration and financing costs related to inventory — directly to each product, giving retailers a more accurate picture of true profitability at the product level. A product with a good gross margin but high handling costs and large space requirements may be less profitable than one with a lower margin but very low direct costs. Traditional gross profit analysis misses these below-the-gross-profit costs.

Answer: C. Value engineering (or value analysis) examines each element of a product's design to identify whether the required function can be achieved at a lower cost — for example, by substituting a cheaper material that performs equally well, simplifying the design, or redesigning for easier manufacture. The goal is to close the cost gap identified by target costing without sacrificing the attributes customers value. Simply adding features, increasing volume or outsourcing are separate approaches that may not close the cost gap and could introduce their own problems.

Answer: D. When production exceeds sales, closing inventory exceeds opening inventory. Under absorption costing, the closing inventory carries a proportion of fixed overhead, which is deferred to the next period rather than being charged to the current period's income statement. As a result, the fixed overhead charged in the income statement is less than the total incurred. Marginal costing would charge all fixed overhead in the period regardless of inventory levels. The amount charged in the income statement (absorbed overhead) is adjusted by over/under-absorption to give the actual overhead figure.