Question

Problem 5-45 Volume-Based Costing versus ABC [LO 5-1, 5-3, 5-5]

[The following information applies to the questions displayed below.]

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	$	210,000			$	270,000			$	263,000
Cost of direct labor		255,000				239,000				268,000
Number of direct labor hours		7,250				6,850				2,050
Number of capsules		1,050,000				505,000				305,000

ADA has identified the following activities and cost drivers and has assigned them a total overhead cost of $202,500.

Activity	Cost Driver	Budgeted Overhead Cost				Budgeted Cost Driver Volume
Machine setup	Setup hours	$	16,500				1,650
Plant management	Number of Workers		36,500				1,250
Supervision of direct labor	Direct labor hours		46,500				16,500
Quality inspection	Inspection hours		50,900				1,075
Order expediting	Customers served		52,100				670
Total overhead		$	202,500

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		225				625				825
Number of workers		225				425				625
Direct labor hours		7,250				6,850				2,050
Inspection hours		175				225				725
Customers served		50				105				525

Use the activity-based cost system to calculate the unit cost of each product. (Round intermediate calculations to 2 decimal places. Round "Cost per capsule" to 2 decimal places.)

	Diomycin Homycin Addolin Direct Materials $210,000.00 $270,000.00 $263,000.00 Direct Labor $255,000.00 $239,000.00 $268,000.00 Overhead Total Cost $465,000.00 $509,000.00 $531,000.00 Packets produced $1,050,000.00 $505,000.00 $305,000.00 Cost per capsule

Part 1

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.

Overhead Rate per Labour Hour= Total Overhead/Total Direct Labour Hour = $202,500/(7,250+6,850+2,050) = $202,500/16,150 = $12.54 per direct labour hour

	Diomycin	Homycin	Addolin
Cost of Direct Material	$210,000	$270,000	$263,000
Cost of Direct Labour	$255,000	$239,000	$268,000
Overhead Cost	$90,900 ($12.54*7,250)	$85,900 ($12.54*6,850)	$25,700 ($12.54*2,050)
Total Product Cost	$555,900	$594,900	$556,700
Number of Capsules	1,050,000	505,000	305,000
Unit cost of each product	$0.53 ($555,900/1,050,000)	$1.18 ($594,900/505,000)	$1.83 ($556,700/305,000)

2. Activity Based Costing System

Activity	Budgeted Overhead Cost	Budgeted Cost Driver	Cost Driver Rate
Machine Setup	$16,500	1,650	$10 per setup hour
Plant Management	$36,500	1,250	$29.2 No. of worker
Supervision of Direct Labour	$46,500	16,500	$2.82 per direct labour hour
Quality Inspection	$50,900	1,075	$47.35 per inspection hour
Order Expediting	$52,100	670	$77.76 per customer served

calculation the unit cost of each product

	Diomycin	Homycin	Addolin
Direct Material	$210,000	$270,000	$263,000
Direct Labour	$255,000	$239,000	$268,000
Overhead Cost:-
Machine Setup	$2,250 ($10*225)	$6,250 ($10*625)	$8,250 ($10*825)
Plant Management	$6,570 ($29.2*225)	$12,410 ($29.2*425)	$18,250 ($29.2*625)
Supervision of Direct Labour	$20,445 ($2.82*7,250)	$19,317 ($2.82*6,850)	$5,781 ($2.82*2,050)
Quality Inspection	$8,286 ($47.35*175)	$10,654 ($47.35*225)	34,329 ($47.35*725)
Order Expediting	$3,888 ($77.76*50)	$8,165 ($77.76*105)	$40,824 ($77.76*525)
Total Overhead Cost	$41,439	$56,796	$107,434
Total Product Cost	$506,439	$565,796	$638,434
Number of Capsules	1,050,000	505,000	305,000
Unit Product cost per unit	$0.48	$1.12	$2.09