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 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

Solution 1:

Predetermined overhead rate = Estimated overhead / Estimated direct labor hours

$196,500 / 15300 = $12.84

Computation of unit cost of each product
Particulars	Diomycin	Homycin	Addolin
Direct materials	$198,000	$258,000	$251,000
Direct labor	$243,000	$227,000	$256,000
Applied overhead	$91,549	$86,413	$24,781
Total manufacturing costs	$532,549	$571,413	$531,781
Nos of capsules	930000	493000	293000
Cost per unit	$0.57	$1.16	$1.81

Solution 2:

Computation of overhead assigned to product - Activity Based Costing
Activity	Cost	Cost Driver	Qty of cost driver	Allocation rate	Diomycin		Homycin		Addolin
					Allocation Qty	Allocated Overhead	Allocation Qty	Allocated Overhead	Allocation Qty	Allocated Overhead
Machine Setup	$15,300	Setup hours	1530	$10.00	165	$1,650	565	$5,650	765	$7,650
Plant management	$35,300	Nos of workers	1130	$31.24	165	$5,154	365	$11,402	565	$17,650
Supervision of direct labor	$45,300	Direct labor hours	15300	$2.96	7130	$21,110	6730	$19,926	1930	$5,714
Quality Inspection	$49,700	Inspection hours	1015	$48.97	115	$5,631	165	$8,079	665	$32,562
Order expediting	$50,900	Customer served	610	$83.44	38	$3,171	93	$7,760	465	$38,801
Total	$196,500					$36,717		$52,818		$102,377

Computation of unit cost of each product
Particulars	Diomycin	Homycin	Addolin
Direct materials	$198,000.00	$258,000.00	$251,000.00
Direct labor	$243,000.00	$227,000.00	$256,000.00
Applied overhead	$36,717	$52,818	$102,377
Total manufacturing costs	$477,717	$537,818	$609,377
Nos of capsules	930000	493000	293000
Cost per unit	$0.51	$1.09	$2.08