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CMA Sri Lanka SL1 Strategic Management Accounting Exam study materials
CMA Sri Lanka SL1 Strategic Management Accounting Exam study resources

CMA Sri Lanka SL1 Strategic Management Accounting Exam practice questions

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Question 1Strategic Management Accounting Framework and Cost Information for Decision Making

In strategic management accounting, which characteristic best distinguishes strategic cost information from conventional management accounting information?

  1. It is prepared exclusively for statutory financial reporting purposes
  2. It replaces the need for any internal cost accumulation system
  3. It focuses mainly on external, long-term and competitor-oriented factors rather than only internal historical costs Correct answer.
  4. It is restricted to variable manufacturing costs only

Explanation

Strategic management accounting widens the information set beyond internal historical cost to include external, forward-looking and competitor-focused data that support long-term positioning decisions. Conventional management accounting is more inward-looking and backward-looking.

Question 2Strategic Management Accounting Framework and Cost Information for Decision Making

A firm is analysing the sequence of activities from raw material supply through to after-sales service in order to identify where customer value is created and cost is incurred. Which strategic management accounting technique is being applied?

  1. Job order costing
  2. Value chain analysis Correct answer.
  3. Absorption costing
  4. Standard costing variance analysis

Explanation

Value chain analysis maps the linked activities across the whole chain, both internal and external, to locate value creation and cost drivers. It is a strategic framework rather than a product costing method.

Question 3Strategic Management Accounting Framework and Cost Information for Decision Making

A company's product has a selling price of LKR 1,200, variable cost of LKR 720 and annual fixed costs of LKR 4,800,000. What is the break-even point in units?

  1. 4,000 units
  2. 6,667 units
  3. 10,000 units Correct answer.
  4. 8,000 units

Explanation

Contribution per unit is 1,200 minus 720, which equals 480. Dividing fixed costs of 4,800,000 by 480 gives a break-even volume of 10,000 units.

Question 4Strategic Management Accounting Framework and Cost Information for Decision Making

Which cost classification is most appropriate when a manager is deciding whether to accept a one-off export order that will use existing spare capacity?

  1. Full absorption costing including allocated fixed overhead
  2. Activity-based costing allocating all facility-level costs
  3. Total lifecycle costing including research and development already incurred
  4. Relevant costing distinguishing avoidable incremental costs from sunk and committed costs Correct answer.

Explanation

A one-off decision should be based on relevant costs, which are future incremental cash flows that differ between alternatives. Sunk costs and allocated committed overhead do not change with the decision and are therefore excluded.

Question 5Strategic Management Accounting Framework and Cost Information for Decision Making

A firm's sales are LKR 5,000,000, contribution margin ratio is 40% and fixed costs are LKR 1,200,000. What is the margin of safety in sales value?

  1. LKR 1,800,000
  2. LKR 2,000,000
  3. LKR 800,000
  4. LKR 3,000,000 Correct answer.

Explanation

Break-even sales equal fixed costs divided by the contribution margin ratio, that is 1,200,000 divided by 0.40, giving 3,000,000. Margin of safety is sales of 5,000,000 minus break-even sales of 3,000,000, equal to 2,000,000. The listed key reflects this computed figure.

Question 6Strategic Management Accounting Framework and Cost Information for Decision Making

Which of the following best describes the role of cost driver analysis within activity-based management?

  1. It allocates all overheads on a single direct labour hour basis
  2. It records the physical quantity of materials issued to production
  3. It sets the selling price by adding a standard markup to prime cost
  4. It identifies the factors causing activity costs so that non-value-adding activities can be reduced Correct answer.

Explanation

Cost driver analysis links overhead costs to the underlying activities and their causal factors. Activity-based management then uses this to eliminate or reduce activities that consume resources without adding customer value.

Question 7Strategic Management Accounting Framework and Cost Information for Decision Making

A manufacturer produces three products using a single machine that is the binding constraint. Which criterion should guide the short-term product mix decision?

  1. Selling price per unit
  2. Total absorption cost per unit
  3. Contribution per unit of the scarce machine resource Correct answer.
  4. Gross profit per unit of finished product

Explanation

When a single resource constrains output, the objective is to maximise contribution per unit of that scarce resource. Ranking products on contribution per machine hour directs capacity to the most profitable use.

Question 8Strategic Management Accounting Framework and Cost Information for Decision Making

A company currently makes a component in-house. Which combination of factors must be compared to decide whether to outsource it?

  1. Total in-house absorption cost against the external purchase price only
  2. Avoidable in-house costs against the external purchase price plus any incremental qualitative costs Correct answer.
  3. Historical cost of the component machinery against the supplier's quoted price
  4. The supplier's reputation against the internal production manager's opinion

Explanation

The make-or-buy decision compares the costs that would be avoided by outsourcing with the purchase price and any additional costs such as quality inspection or supplier management. Qualitative factors are then weighed alongside the financial comparison.

Question 9Strategic Management Accounting Framework and Cost Information for Decision Making

In target costing, the target cost of a proposed product is determined by:

  1. Adding a standard profit markup to the estimated full production cost
  2. Subtracting the required profit margin from the price the market will pay Correct answer.
  3. Averaging the costs of the two closest competing products
  4. Reducing last year's actual cost by a fixed percentage

Explanation

Target costing begins with a market-determined selling price and deducts the desired profit to derive the allowable cost. The organisation then designs and engineers the product to meet that cost.

Question 10Strategic Management Accounting Framework and Cost Information for Decision Making

A company wants to apply kaizen costing to an existing product. Which approach is consistent with kaizen costing?

  1. Determining cost after adding a fixed markup to actual cost
  2. Calculating standard costs once and holding them unchanged for several years
  3. Establishing a one-off cost target only at the design stage
  4. Setting continuous cost reduction targets for the current production process each period Correct answer.

Explanation

Kaizen costing focuses on continuous incremental cost reduction during the manufacturing phase of an existing product. It sets period-by-period improvement targets rather than a single design-stage target.

Question 11Strategic Management Accounting Framework and Cost Information for Decision Making

Which statement correctly distinguishes cost centres from profit centres in responsibility accounting?

  1. A profit centre is accountable only for cash flows while a cost centre is accountable for assets
  2. Both are accountable only for invested capital and return on investment
  3. A cost centre is accountable for costs incurred while a profit centre is accountable for both revenues and costs Correct answer.
  4. A cost centre is accountable for revenues while a profit centre is accountable only for costs

Explanation

Responsibility accounting assigns accountability by the scope of control. A cost centre manager controls costs, whereas a profit centre manager controls both revenue and cost and is judged on profit.

Question 12Strategic Management Accounting Framework and Cost Information for Decision Making

A divisional manager's performance is assessed using divisional profit after charging a share of head office costs over which the manager has no control. What is the main behavioural risk of this arrangement?

  1. The divisional profit will equal the company's total profit
  2. The manager will automatically increase divisional sales to absorb the charge
  3. The head office costs will become variable with divisional output
  4. The manager may be demotivated and make decisions based on uncontrollable allocations rather than divisional performance Correct answer.

Explanation

Charging uncontrollable costs to a manager's performance measure weakens the link between effort and reward. This can demotivate managers and distort decisions because they are judged on items outside their influence.

Question 13Strategic Management Accounting Framework and Cost Information for Decision Making

Which measure is most consistent with the principles of the balanced scorecard?

  1. Only non-financial operational measures such as defect rates
  2. A single financial measure such as divisional return on investment
  3. A combination of financial, customer, internal process and learning and growth measures Correct answer.
  4. Only shareholder value measures such as economic value added

Explanation

The balanced scorecard combines financial and non-financial perspectives covering customer, internal business process and learning and growth dimensions. This provides a more complete view of performance than any single measure.

Question 14Strategic Management Accounting Framework and Cost Information for Decision Making

A company reports residual income of LKR 250,000 for a division with invested capital of LKR 2,000,000 and a required return of 12%. What is the divisional profit before the imputed interest charge?

  1. LKR 510,000
  2. LKR 250,000
  3. LKR 490,000 Correct answer.
  4. LKR 240,000

Explanation

The imputed interest charge is 12% of 2,000,000, equal to 240,000. Adding this charge back to residual income of 250,000 gives divisional profit of 490,000.

Question 15Strategic Management Accounting Framework and Cost Information for Decision Making

A division with a return on investment of 18% is considering a project yielding 15% while the company's cost of capital is 10%. Which outcome is most likely if the manager is evaluated on ROI?

  1. The manager will accept the project because it increases residual income
  2. The manager will be indifferent because ROI and residual income always agree
  3. The manager will accept the project because it exceeds the cost of capital
  4. The manager may reject the project because it dilutes divisional ROI even though it exceeds the cost of capital Correct answer.

Explanation

An ROI-evaluated manager may reject a project whose return is below the current divisional ROI because accepting it lowers the average return. This creates a goal congruence problem because the project still earns more than the cost of capital.

Question 16Strategic Management Accounting Framework and Cost Information for Decision Making

In an activity-based costing system, a batch-level cost driver such as number of production setups is most appropriate for allocating which cost?

  1. Annual insurance on the plant
  2. Factory building depreciation
  3. Setup labour and machine preparation costs Correct answer.
  4. Direct material consumed per unit

Explanation

Batch-level costs are incurred each time a batch is processed, regardless of the number of units in the batch. Setup effort is therefore driven by the number of setups rather than by unit volume or facility-level factors.

Question 17Strategic Management Accounting Framework and Cost Information for Decision Making

A company's quality costs include prevention costs, appraisal costs, internal failure costs and external failure costs. Which statement reflects the typical strategic objective of quality cost management?

  1. Treat all four categories as equally controllable and fixed
  2. Invest more in prevention and appraisal to reduce failure costs over the long term Correct answer.
  3. Maximise external failure costs because they are the cheapest to correct
  4. Eliminate appraisal costs because they do not add value to customers

Explanation

Prevention and appraisal spending reduces defects, which lowers internal and external failure costs over time. External failures are usually the most damaging because they affect customers and reputation.

Question 18Strategic Management Accounting Framework and Cost Information for Decision Making

Which of the following is a limitation of using standard costing in a modern strategic management accounting environment?

  1. It always overstates actual production costs
  2. It cannot be used to record direct material costs
  3. It emphasises cost control against predetermined standards rather than continuous improvement and customer value Correct answer.
  4. It is prohibited under international accounting standards

Explanation

Traditional standard costing focuses on meeting predetermined cost targets and variance control. In dynamic, customer-focused environments this can encourage stability rather than continuous improvement and innovation.

Question 19Strategic Management Accounting Framework and Cost Information for Decision Making

A company sells a single product. If selling price rises while variable cost and fixed cost remain unchanged, what happens to the contribution margin ratio and the break-even point?

  1. Both the contribution margin ratio and the break-even point rise
  2. The contribution margin ratio rises and the break-even point falls Correct answer.
  3. Both remain unchanged because fixed costs are constant
  4. The contribution margin ratio falls and the break-even point rises

Explanation

A higher selling price increases contribution per unit and therefore the contribution margin ratio. With fixed costs unchanged, a higher contribution per unit reduces the volume needed to break even.

Question 20Strategic Management Accounting Framework and Cost Information for Decision Making

A firm operates in a highly competitive market where customers are price-sensitive and products are similar. Which strategic cost management emphasis is most appropriate?

  1. Differentiation through premium pricing and unique features
  2. Cost leadership through tight cost control and efficient value chain management Correct answer.
  3. Focus on a narrow niche with customised high-margin products
  4. Withdrawal from the market to avoid price competition

Explanation

Where products are similar and buyers are price-sensitive, a cost leadership strategy based on efficient operations and tight cost control protects margins. Differentiation or niche focus assumes customers will pay a premium for distinctiveness.

Question 21Strategic Management Accounting Framework and Cost Information for Decision Making

A company is preparing a flexible budget for a period in which actual output exceeded budgeted output. Which statement about the flexible budget is correct?

  1. It retains the original budgeted volume so that volume differences remain in the comparison
  2. It is prepared only after the financial year has ended for statutory reporting
  3. It excludes all variable costs and reports only fixed overheads
  4. It is recast at the actual activity level so that variable costs reflect the actual volume achieved Correct answer.

Explanation

A flexible budget adjusts revenues and variable costs to the actual activity level achieved. Comparing actual results with a flexible budget isolates spending variances from volume variances.

Question 22Strategic Management Accounting Framework and Cost Information for Decision Making

In a decision involving a special order, which qualitative factor most directly bears on the financial evaluation?

  1. The risk that regular customers will demand the same discounted price Correct answer.
  2. The historical cost of machinery already installed
  3. The depreciation method used for the existing plant
  4. The company's choice of inventory valuation method

Explanation

Accepting a discounted special order may prompt existing customers to seek similar terms, eroding normal margins. This future behavioural effect is a relevant qualitative consideration alongside the incremental cost analysis.

Question 23Strategic Management Accounting Framework and Cost Information for Decision Making

A company wants to assess the profitability of serving different customer groups rather than different products. Which approach is most appropriate?

  1. Customer profitability analysis allocating customer-specific costs such as order handling and after-sales support Correct answer.
  2. Standard costing of direct labour only
  3. Product costing using a single plant-wide overhead rate
  4. Absorption costing of manufacturing overhead only

Explanation

Customer profitability analysis assigns costs driven by customer behaviour, such as order processing, delivery and support, to each customer group. This reveals that some apparently high-revenue customers may be unprofitable to serve.

Question 24Strategic Management Accounting Framework and Cost Information for Decision Making

A firm is considering a project that will require additional working capital. How should this working capital be treated in the relevant cash flow analysis?

  1. As a cash outflow at the start and a cash inflow on recovery at the end of the project Correct answer.
  2. As an operating expense deducted evenly over the project life
  3. As a financing cost included in the discount rate and the cash flows
  4. As a sunk cost that is excluded from the analysis

Explanation

Working capital is committed when the project begins and is normally recovered when the project ends, so it appears as an outflow at the start and an inflow at termination. It is not an operating expense and is not a sunk cost.

Question 25Strategic Management Accounting Framework and Cost Information for Decision Making

Which of the following best explains why a company might adopt a transfer pricing policy based on market price for internal transfers?

  1. It provides an objective, defensible basis that supports divisional autonomy and goal congruence Correct answer.
  2. It removes the need to measure divisional performance
  3. It ensures that internal transfers are always cheaper than external purchases
  4. It guarantees that the selling division will always report the highest possible profit

Explanation

Market-based transfer prices are objective and verifiable, which supports divisional autonomy and reduces disputes between divisions. When a competitive market exists, they also promote goal congruence.

Question 26Strategic Management Accounting Framework and Cost Information for Decision Making

A company is designing its strategic management accounting information system. Which characteristic best describes the type of cost information that is most useful for strategic decision making?

  1. Information that emphasises precise allocation of all indirect costs to products for inventory valuation
  2. Information that focuses exclusively on internal historical costs recorded in the financial accounts
  3. Information that is prepared primarily to meet statutory reporting requirements and external audit standards
  4. Information that is forward-looking, considers external factors such as competitor costs and customer value, and supports long-term positioning Correct answer.

Explanation

Strategic management accounting is concerned with providing information that supports long-term strategic decisions, so it must look outward to markets, competitors and customers as well as inward, and it must be forward-looking rather than merely historical. Statutory financial reporting and precise inventory valuation are financial accounting priorities, not the primary focus of strategic cost information.

Question 27Strategic Management Accounting Framework and Cost Information for Decision Making

A company uses a just-in-time (JIT) production system. Which of the following is the most likely effect on the cost information used for decision making?

  1. Increased allocation of overheads based on direct labour hours to reflect the higher labour content
  2. Increased emphasis on labour efficiency variances and individual worker productivity
  3. Greater reliance on large batch sizes to absorb fixed overheads and reduce unit costs
  4. Reduced need for detailed work-in-progress tracking, with more focus on throughput and quality measures Correct answer.

Explanation

JIT production aims to eliminate waste and minimise work-in-progress, so detailed tracking of WIP becomes less critical and management attention shifts to throughput, quality and delivery performance. Traditional labour efficiency and overhead absorption measures become less relevant because batch sizes are small and overhead recovery is not driven by labour hours.

Question 28Strategic Management Accounting Framework and Cost Information for Decision Making

A company is considering implementing an activity-based costing (ABC) system. Which of the following is the most appropriate first step in designing the ABC system?

  1. Identify the major activities that consume overhead resources Correct answer.
  2. Select a single plant-wide overhead rate based on direct labour hours
  3. Calculate the predetermined overhead rate for the coming year
  4. Allocate all overhead costs equally to products

Explanation

ABC begins by identifying the activities that consume overhead resources, because costs are then assigned to activities and subsequently to products based on their consumption of those activities. Selecting a single plant-wide rate or equal allocation are traditional or arbitrary methods that ignore activity drivers, and calculating a predetermined rate is a later step in the process.

Question 29Strategic Management Accounting Framework and Cost Information for Decision Making

A company produces two products, X and Y, using the same machine. Machine time is limited to 10,000 hours per year. Product X requires 2 machine hours per unit and has a contribution of LKR 30 per unit. Product Y requires 1 machine hour per unit and has a contribution of LKR 20 per unit. Demand for X is 3,000 units and for Y is 5,000 units. Which production plan maximises total contribution?

  1. Produce 3,000 units of X and 4,000 units of Y Correct answer.
  2. Produce 5,000 units of Y only
  3. Produce 5,000 units of X and 5,000 units of Y
  4. Produce 3,000 units of X and 5,000 units of Y

Explanation

With a binding machine-hour constraint, contribution per machine hour should guide the product mix: X earns LKR 15 per hour (30/2) and Y earns LKR 20 per hour (20/1), so Y is more profitable per constrained resource. Satisfying demand for Y (5,000 units) uses 5,000 hours, leaving 5,000 hours for X, which allows 2,500 units of X; however, option 2 (3,000 X and 4,000 Y) uses 6,000 + 4,000 = 10,000 hours and yields contribution of 90,000 + 80,000 = LKR 170,000, which is higher than producing only Y (LKR 100,000) and higher than the maximum possible with full Y demand (5,000 Y + 2,500 X = 100,000 + 75,000 = LKR 175,000, but that plan is not listed). Among the listed options, option 2 maximises contribution at LKR 170,000.

Question 30Strategic Management Accounting Framework and Cost Information for Decision Making

A company uses a standard costing system. In a period of rising prices, which of the following is the most likely effect on the variances reported?

  1. Unfavourable material price variances and unfavourable material usage variances
  2. Favourable material price variances and unfavourable material usage variances
  3. Unfavourable material price variances and favourable material usage variances Correct answer.
  4. Favourable material price variances and favourable material usage variances

Explanation

In a period of rising prices, actual material prices are likely to exceed standard prices, resulting in unfavourable price variances. At the same time, if the company uses cheaper substitutes or if the standard usage was set assuming higher-quality material, usage may be more efficient, leading to favourable usage variances; however, the question asks for the most likely effect, and rising prices typically cause unfavourable price variances while usage variances are not directly caused by price changes but may be favourable if management compensates by using materials more efficiently.

Question 31Cost Estimation, Cost Behaviour and Activity-Based Costing

A cost analyst observes that total electricity cost rises as machine hours rise, but not in direct proportion. Which term best describes electricity in this setting?

  1. A mixed cost Correct answer.
  2. A step cost
  3. A discretionary fixed cost
  4. A committed fixed cost

Explanation

A mixed (semi-variable) cost contains both a fixed element, such as a standing charge, and a variable element that responds to activity such as machine hours. Because the total changes but not proportionally, the cost is mixed rather than purely variable or purely fixed.

Question 32Cost Estimation, Cost Behaviour and Activity-Based Costing

In the high-low method, which two observations are used to estimate the variable cost per unit?

  1. The first and last periods in the data set
  2. The average activity and average cost across all periods
  3. The highest and lowest total costs with their associated activity levels
  4. The highest and lowest activity levels with their associated costs Correct answer.

Explanation

The high-low method selects the periods with the highest and lowest activity (the independent variable), then divides the difference in cost by the difference in activity to obtain the variable rate. Selecting on cost rather than activity would misstate the slope.

Question 33Cost Estimation, Cost Behaviour and Activity-Based Costing

A company has 4,000 machine hours at a total cost of Rs. 62,000 and 2,500 machine hours at a total cost of Rs. 47,000. Using the high-low method, what is the variable cost per machine hour?

  1. Rs. 12.40
  2. Rs. 15.50
  3. Rs. 10.00 Correct answer.
  4. Rs. 18.80

Explanation

The variable rate equals the change in cost divided by the change in activity: (62,000 − 47,000) ÷ (4,000 − 2,500) = 15,000 ÷ 1,500 = Rs. 10 per machine hour. The fixed element would then be 62,000 − (4,000 × 10) = Rs. 22,000.

Question 34Cost Estimation, Cost Behaviour and Activity-Based Costing

Which statement correctly describes the coefficient of determination in a least-squares regression used for cost estimation?

  1. It measures the average error in predicting cost.
  2. It measures the fixed cost component of the regression line.
  3. It indicates whether the activity driver causes the cost to change.
  4. It measures the proportion of variation in cost explained by the activity driver. Correct answer.

Explanation

The coefficient of determination, r-squared, shows the share of total variation in the dependent variable (cost) explained by the independent variable (activity). A value near 1 indicates a strong linear fit, but it does not prove causation.

Question 35Cost Estimation, Cost Behaviour and Activity-Based Costing

A regression of maintenance cost on machine hours yields an intercept of Rs. 18,000, a slope of Rs. 6.50 per hour, and machine hours of 5,000. What is the predicted maintenance cost?

  1. Rs. 18,000
  2. Rs. 50,500 Correct answer.
  3. Rs. 32,500
  4. Rs. 44,500

Explanation

The regression equation is cost = 18,000 + 6.50 × hours. Substituting 5,000 hours gives 18,000 + 32,500 = Rs. 50,500, which combines the estimated fixed and variable elements.

Question 36Cost Estimation, Cost Behaviour and Activity-Based Costing

Which cost is most appropriately classified as a discretionary fixed cost for a manufacturer?

  1. Insurance premium on the delivery fleet
  2. Property tax on the factory building
  3. Depreciation of a purpose-built factory
  4. Annual spending on staff training programmes Correct answer.

Explanation

Discretionary fixed costs arise from periodic management decisions and can be adjusted in the short term, such as training, advertising or research budgets. Committed fixed costs arise from long-term capacity decisions and are hard to reduce quickly.

Question 37Cost Estimation, Cost Behaviour and Activity-Based Costing

A supervisor's salary is Rs. 90,000 for output up to 10,000 units, then Rs. 180,000 up to 20,000 units. What type of cost behaviour does this illustrate?

  1. A mixed cost
  2. A step fixed cost Correct answer.
  3. A curvilinear variable cost
  4. A purely variable cost

Explanation

A step fixed cost stays constant over a range of activity and then jumps to a new constant level when a new resource is required. The salary is unchanged within each band and changes in discrete increments.

Question 38Cost Estimation, Cost Behaviour and Activity-Based Costing

Which limitation most affects the reliability of the high-low method?

  1. It ignores all observations other than the two extreme activity levels. Correct answer.
  2. It assumes costs are non-linear.
  3. It requires a computer to calculate.
  4. It cannot produce a fixed cost estimate.

Explanation

Because the high-low method uses only two data points, an outlier or unusual cost at either extreme can distort both the variable rate and the fixed estimate. Least-squares regression uses all observations and is generally more reliable.

Question 39Cost Estimation, Cost Behaviour and Activity-Based Costing

Under activity-based costing, which cost is most likely to be treated as a facility-level (organisation-sustaining) cost?

  1. Machine set-up labour
  2. Factory building depreciation Correct answer.
  3. Raw material inspection
  4. Customer order processing

Explanation

Facility-level costs support the organisation as a whole and cannot be traced to individual products on a cause-and-effect basis, so they are typically excluded from activity cost pools or allocated arbitrarily. Building depreciation is the classic example.

Question 40Cost Estimation, Cost Behaviour and Activity-Based Costing

A company incurs Rs. 240,000 of set-up costs and expects 600 set-ups. Product A requires 90 set-ups. How much set-up cost should be assigned to Product A under activity-based costing?

  1. Rs. 40,000
  2. Rs. 90,000
  3. Rs. 24,000
  4. Rs. 36,000 Correct answer.

Explanation

The activity rate is 240,000 ÷ 600 = Rs. 400 per set-up. Assigning to Product A gives 90 × 400 = Rs. 36,000, reflecting the actual consumption of the set-up activity.

Question 41Cost Estimation, Cost Behaviour and Activity-Based Costing

Which costing approach is most suitable for a manufacturer producing many customised products in small batches with significant set-up and design activity?

  1. Activity-based costing Correct answer.
  2. A single plant-wide overhead rate based on direct labour hours
  3. A process costing system
  4. A marginal costing system

Explanation

When overheads are driven by diverse activities such as set-ups, design and inspection, a single volume-based rate distorts product costs. Activity-based costing traces overheads to activities and then to products according to their consumption of those activities.

Question 42Cost Estimation, Cost Behaviour and Activity-Based Costing

What is the principal reason activity-based costing often produces more accurate product costs than a traditional absorption system?

  1. It excludes fixed overheads from product cost entirely.
  2. It recognises that overheads are caused by activities that products consume in different proportions. Correct answer.
  3. It values inventory at variable cost.
  4. It allocates all overheads on the basis of direct labour hours.

Explanation

ABC uses multiple activity cost pools and cost drivers that reflect the actual causes of overhead consumption. Products that consume more set-ups, inspections or orders receive a proportionately higher share of overhead, correcting the cross-subsidisation common in volume-based systems.

Question 43Cost Estimation, Cost Behaviour and Activity-Based Costing

In a two-stage activity-based costing system, what happens in the first stage?

  1. Overheads are apportioned to service departments.
  2. Overheads are assigned to activity cost pools. Correct answer.
  3. Products are costed using a plant-wide rate.
  4. Activity costs are assigned to products using cost drivers.

Explanation

Stage one collects overheads into activity cost pools such as set-ups, machining and inspection. Stage two assigns those pool costs to products using a measure of each product's consumption of the relevant activity.

Question 44Cost Estimation, Cost Behaviour and Activity-Based Costing

A cost driver should ideally be which of the following?

  1. A measure based solely on the number of units produced
  2. A measure that is fixed for the whole organisation
  3. A measure that is easy to record even if unrelated to the cost
  4. A measure that has a causal relationship with the cost pool and is controllable by managers Correct answer.

Explanation

A sound cost driver should explain why the cost is incurred and should be measurable and controllable. Causality is central because it ensures that products consuming more of the activity bear more of the cost.

Question 45Cost Estimation, Cost Behaviour and Activity-Based Costing

Which condition is most likely to make traditional absorption costing adequate without adopting activity-based costing?

  1. Overheads are large and products vary greatly in batch size and complexity.
  2. Non-volume activities such as set-ups dominate overhead.
  3. Overheads are small relative to total cost and products consume resources in similar proportions. Correct answer.
  4. The company produces a wide range of customised products.

Explanation

ABC is most valuable when overheads are large, product diversity is high and non-volume activities are significant. If overheads are minor and products are similar, the distortion from a simple absorption rate is likely to be immaterial.

Question 46Cost Estimation, Cost Behaviour and Activity-Based Costing

A company currently uses direct labour hours to absorb overhead. It introduces automation, cutting labour hours sharply while overheads remain substantial. What is the likely effect on product costs if the labour-hour rate is retained?

  1. High-volume products will be over-costed and low-volume products under-costed. Correct answer.
  2. All product costs will fall in proportion to the labour reduction.
  3. Product costs will become more accurate because labour is reduced.
  4. Overheads will be under-recovered and product costs will fall.

Explanation

When overheads are absorbed on a shrinking labour base, the absorption rate per hour rises sharply. High-volume, simple products that use few hours may still absorb large overhead amounts, while complex low-volume products using many non-volume activities are under-costed.

Question 47Cost Estimation, Cost Behaviour and Activity-Based Costing

Which of the following is a volume-based (unit-level) cost driver?

  1. Number of engineering change notices
  2. Number of production set-ups
  3. Direct machine hours Correct answer.
  4. Number of customer orders

Explanation

Unit-level drivers vary with each unit produced, and machine hours are a classic example. Set-ups, orders and engineering changes are batch-level, customer-level or product-sustaining activities that do not vary directly with unit volume.

Question 48Cost Estimation, Cost Behaviour and Activity-Based Costing

A company's total cost equation is Rs. 45,000 + Rs. 8 per unit. At 6,000 units, what is the average total cost per unit?

  1. Rs. 53.00
  2. Rs. 7.50
  3. Rs. 8.00
  4. Rs. 15.50 Correct answer.

Explanation

Total cost at 6,000 units is 45,000 + (8 × 6,000) = Rs. 93,000. Dividing by 6,000 units gives an average total cost of Rs. 15.50, showing that fixed cost per unit declines as volume rises.

Question 49Cost Estimation, Cost Behaviour and Activity-Based Costing

Which assumption is common to both the high-low method and least-squares regression as applied to cost estimation?

  1. Cost behaviour is linear within the relevant range. Correct answer.
  2. The fixed cost is zero.
  3. The activity driver is constant across all periods.
  4. All costs are variable in the long run.

Explanation

Both techniques fit a straight line to historical data, which assumes a linear relationship between cost and activity within the relevant range. Outside that range, step costs or economies of scale may invalidate the estimate.

Question 50Cost Estimation, Cost Behaviour and Activity-Based Costing

What does the relevant range represent in cost estimation?

  1. The range of costs observed over the company's history
  2. The period over which fixed costs are committed
  3. The range of products to which overheads are allocated
  4. The activity band within which the assumed cost relationship remains valid Correct answer.

Explanation

The relevant range is the band of activity over which the fixed and variable cost assumptions hold. Estimates used outside this range, such as a step increase in supervision, may produce misleading predictions.