Question

ADA Pharmaceutical Company produces three drugs—Diomycin, Homycin, and Addolin—belonging to the analgesic (pain-killer) family of medication. Since its inception four years ago, ADA has used a direct labor hour–based system to assign manufacturing overhead costs to products.

Eme Weissman, the president of ADA Pharmaceutical, has just read about activity-based costing in a trade journal. With some curiosity and interest, she asked her financial controller, Takedo Simon, to examine differences in product costs between the firm’s current costing and activity-based costing systems.

ADA has the following budget information for the year:

	Diomycin				Homycin				Addolin
Cost of direct materials	$	198,000			$	258,000			$	251,000
Cost of direct labor		243,000				227,000				256,000
Number of direct labor hours		7,130				6,730				1,930
Number of capsules		930,000				493,000				293,000

ADA has identified the following activities and cost drivers and has assigned them a total overhead cost of $196,500.

Activity	Cost Driver	Budgeted Overhead Cost				Budgeted Cost Driver Volume
Machine setup	Setup hours	$	15,300				1,530
Plant management	Number of Workers		35,300				1,130
Supervision of direct labor	Direct labor hours		45,300				15,300
Quality inspection	Inspection hours		49,700				1,015
Order expediting	Customers served		50,900				610
Total overhead		$	196,500

Takedo selected the cost drivers with the following justifications:

SETUP HOURS: The cost driver of setup hours is used because the same product takes about the same amount of setup time regardless of size of batch. For different products, however, the setup time varies.

NUMBER OF WORKERS: Plant management includes plant maintenance and corresponding managerial duties that make production possible. This activity depends on the number of workers. The more workers involved, the higher the cost.

DIRECT LABOR HOURS: Supervisors spend their time supervising production. The amount of time they spend on each product is proportional to the direct labor hours worked.

INSPECTION HOURS: Inspection involves testing a number of units in a batch. The time varies for different products but is the same for all similar products.

NUMBER OF CUSTOMERS SERVED: The need to expedite production increases as the number of customers served by the company increases. Thus, the number of customers served by ADA is a good measure of expediting production orders.

Takedo gathered the following information about the cost driver volume for each product:

	Diomycin				Homycin				Addolin
Setup hours		165				565				765
Number of workers		165				365				565
Direct labor hours		7,130				6,730				1,930
Inspection hours		115				165				665
Customers served		38				93				465

rev: 09_27_2018_QC_CS-140513

Required:

1. Use the firm’s current costing system to calculate the unit cost of each product.

2. Use the activity-based cost system to calculate the unit cost of each product.

Answer 1

1. Statement showing cost per unit based on persent costing system

	Diomycin ($)	Homycin ($)	Addolin ($)
Particulars	Total cost	Unit	per unit cost	Total cost	Unit	per unit cost	Total cost	Unit	per unit cost
Direct Materials	198000	930000	0.21	258000	493000	0.52	251000	293000	0.86
Direct Labour	243000	930000	0.26	227000	493000	0.46	256000	293000	0.87
Total overhead cost	88730*	930000	0.1	83752*	493000	0.17	24018*	293000	0.08
Total Cost			0.57			1.15			1.81

Per unit Cost = Total Cost/ Number of Units

*Note 1- Statement showing current allocation of overhead cost based on direct labour hour used

Division of Total overhead cost based on direct labour hours
Total overhead cost	196500
	Diomycin	Homycin	Addolin	Total
Direct labour	7130	6730	1930	15790
Appportionment factor	0.45155	0.42622	0.1222	1
Overhead cost	88730	83752	24018	196500

Apportionment factor =   Cost driver(Direct labour hours)

                                                  Total of Cost Driver

Apportioned Overhead cost = Cost Factor X Total Overhead cost

  

2. Statement showing cost per unit based on Activity based cost system

	Diomycin($)		Homycin($)	Addolin($)
Particulars	Total cost	Unit	per unit cost		Total cost		Unit		per unit cost	Total cost	Unit	per unit cost
Direct Materials	198000	930000	0.212903		258000		493000		0.523326572	251000	293000	0.86
Direct Labour	243000	930000	0.26129		227000		493000		0.460446247	256000	293000	0.87
Total overhead cost	36757*	930000	0.039524		53477*		493000		0.108472617	106266*	293000	0.36
Total Cost			0.513717						1.092245436			2.09

*Note 1 -As the firm have adopted activity based system, hence the revised allocation of overhead cost is based on cost driver suitable for each head of overhead cost. Statement shwoing revised allocation of overhead cost of 196500 based on activity based system is shown below-

			Share of overhead cost allocable to each product
Activity	Cost Driver	Budgeted overhead cost	Diomycin	Homycin	Addolin	Total
Machine Setup	Setup hours	15300	1688.629	5782.2742	7829.097	15300
Pant Management	No. of workers	35300	5319.178	11766.667	18214.16	35300
Supervision of Direct labour	Direct labour hours	45300	20455.29	19307.726	5536.985	45300
Quality inspection	Inspection hours	49700	6048.148	8677.7778	34974.07	49700
Order expediting	Customer served	50900	3245.302	7942.4497	39712.25	50900
Total allocated overhead cost			36757	53477	106266	196500

	Diomycin	Homycin	Addolin	Total
Setup hours	165	565	765	1495
No. of workers	165	365	565	1095
Direct labour hours	7130	6730	1930	15790
Inspection hours	115	165	665	945
Customer served	38	93	465	596

Analysis- Acticity based cost system allocate the cost efficiently based on the relevant cost driver incured on each product. Using a blanket allocation rate results inequitable distribution of cost on single factor which may lead to incorect decision making.