Aqua Company produces two products-Alpha and Beta. Alpha has a high market share and is produced in bulk. Production of Beta is based on customer orders and is custom designed. Also, 55% of Beta's cost is shared between design and setup costs, while Alpha's major portions of costs are direct costs. Alpha is using a single cost pool to allocate indirect costs. Which of the following statements is true of Aqua?
A) Aqua will overcost Beta's direct costs as it is using a single cost pool to allocate indirect costs.
B) Aqua will undercost Alpha's indirect costs because alpha has high direct costs.
C) Aqua will overcost Alpha's indirect costs as it is using a single cost pool to allocate indirect costs.
D) Aqua will overcost Beta's indirect costs because beta has high indirect costs.

Question

Quizplus · Accepted Answer

Since Aqua is using a single cost pool to allocate indirect costs, it is likely that Alpha's high direct costs will cause its indirect costs to be overcosted. This is because the single cost pool approach will spread indirect costs evenly across all products based on a common allocation factor, resulting in overallocation of overhead to Alpha. On the other hand, Beta's custom design and setup costs will be undercosted as 55% of its cost is not directly linked to production volume or activity level. Therefore, option C is the correct choice.

Aqua Company Produces Two Products-Alpha and Beta