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	$	197,000			$	257,000			$	250,000
Cost of direct labor		242,000				226,000				255,000
Number of direct labor hours		7,120				6,720				1,920
Number of capsules		920,000				492,000				292,000

ADA has identified the following activities and cost drivers and has assigned them a total overhead cost of $196,000.

Activity	Cost Driver	Budgeted Overhead Cost				Budgeted Cost Driver Volume
Machine setup	Setup hours	$	15,200				1,520
Plant management	Number of Workers		35,200				1,120
Supervision of direct labor	Direct labor hours		45,200				15,200
Quality inspection	Inspection hours		49,600				1,010
Order expediting	Customers served		50,800				605
Total overhead		$	196,000

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		160				560				760
Number of workers		160				360				560
Direct labor hours		7,120				6,720				1,920
Inspection hours		110				160				660
Customers served		37				92				460

rev: 09_27_2018_QC_CS-140513

Required:

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

Use the firm’s current costing 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 $197,000.00 $257,000.00 $250,000.00 Direct Labor $242,000.00 $226,000.00 $255,000.00 Overhead Total Cost $439,000.00 $483,000.00 $505,000.00 Packets produced $920,000.00 $492,000.00 $292,000.00 Cost per capsule

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

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 $197,000.00 $257,000.00 $250,000.00 Direct Labor $242,000.00 $226,000.00 $255,000.00 Overhead Total Cost $439,000.00 $483,000.00 $505,000.00 Packets produced $920,000.00 $492,000.00 $292,000.00 Cost per capsule

Answer 1

Q-1) Current costing system

Particulars Direct Materials Direct Labor Overhead Total Cost Packets produced Cost per capsule Diomycin $197,000 $242,000 $88,548 $527,548 920,000 $0.57 Homycin $257,000 $226,000 $83,574 $566,574 492,000 $1.15 Addolin $250,000 $255,000 $23,878 $528,878 292,000 $1.81

Note - Calculation of Overhead cost using the Direct labor hours

Particulars Number of Direct labor hour Overhead cost Diomycin 7120 $88,548 Homycin 67201 $83,574 Addolin 1920 $23,878 Total 15,760 $196,000 (196,000 x 7,120 / (196,000 x 6,720/(196,000 x 1,920 / 15,760) 15,760) 15,760)

The Overhead cost of 196,000 is apportioned among products based on the direct labor hours used to produce them

Q-2) ABC

Particulars Direct Materials Direct Labor Overhead Total Cost Packets produced Cost per capsule Diomycin $197,000 $242,000 $75,870 $514,870 920,000 $0.56 Homycin $257,000 $226,000 $78,920 $561,920 492,000 $1.14 Addolin $250,000 $255,000 $43,600 $548,600 292,000 $1.88

Note- 1) Calculation of Cost Driver rate

Budgeted Overhead Cost $15,200 Activity Budgeted Cost Driver Volume 1,520 Cost Driver rate Machine setup $10 Plant management $35,200 1,120 $31 Cost Driver Setup hours Number of Workers Direct labor hours Inspection hours Customers served Supervision of direct labor $45,200 15,200 $3 Quality inspection $49,600 1,010 $49 605 $84 Order expediting Total overhead $50,800 $196,000

Note - 2) Calculation of Overhead cost

Cost Driver Cost Driver rate $10 $31 Setup hours Number of workers Direct labor hours Inspection hours Customers served Total Diomycin Cost Driver quantity 160 160 7,120 110 Homycin Cost Driver quantity Cost 560 $5,600 360 $3,600 6,720 $67,200 160 $1,600 92 $920 $78,920 Cost $1,600 $1,600 $71,200 $1,100 $370 $75,870 Addolin Cost Driver quantity 760 560 1,920 660 $3 $49 Cost $7,600 $5,600 $19,200 $6,600 $4,600 $43,600 $84 37 460

In this case the excess costs above the pre determined overhead costs are applied to relevant products (being the relevant cost objects). Under ABC the overhead costs are allocated more precise than that was under Labor hour based costing. Alternatively the excess overhead costs under the ABC method can also be charged off to Cost of goods sold

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