ABC Pharma a case study on Activity Based Costing Established in the year 2000, XYZ Pharma is a credible drug manufacturer which has strengthened patented drugs over the last two decades and produces three products, X, Y, and Z.

It did reasonably well in terms of market share and penetration in the past but over the last 3 years or so it is facing stiff competition, and sluggish demand and is unable to understand why

as there has been no drop-in product quality as endorsed by the Quality Teams.

It hence appointed a drug consultant to study the processes and furnish the following information to it, to conduct a due-diligence and examine and advise the suitable course of action in terms of the way ahead. The drug consultant has suggested that it should now switch to Activity Based Costing as:

It has multiple products spread across geographies.

It is now fairly established and hence the cost-benefit case would suggest the switch as financially viable.

An extract of the evaluation report is as under:

It requires 3 production runs to produce 5000 units of X, 5 production runs to produce 7500 Units of Y, and 7 production runs to produce 10000 units of Z.

The material requirements are as under:

10,000 kgs @ Rs 10/kg for X

12,500 kgs @ Rs 8/kg for Y and

15,000 kgs @ Rs 6/ kg for Z

It takes a total of 15,000 hours each to produce X and Y and 8000 hours to produce Z respectively. Labour is paid @ Rs 20/hour.

The company also incurs Rs 760,000 in overhead costs. These are allocated amongst the products basis the labour hour rate. The desired margin is 25% on the selling price for all divisions. The company is struggling with inefficient pricing, in some cases it is not able to penetrate the market as the products seem overpriced whereas in some cases, the products seem underpriced thereby eroding margins. Hence, it has decided to switch to Activity Based Costing.

It has split the overhead costs as under, after a thorough evaluation of the costs, and identification of cost drivers to enable the assignment of activity costs to cost objects:

Set Up Costs of Rs 450,000 (driver: Production Runs)

Material Handling Costs of Rs 310,000 (driver: Material Consumption)

You are now required to arrive at the costs per unit of X, Y, and Z and estimate the selling prices if the desired margin is still mandated at 25% on the selling price for all divisions. 1.What are the costs & selling prices per unit if the legacy absorption costing system is followed? 2.What are the costs & selling prices per unit if the activity-based costing system is followed? What is your observation, are the products accurately / under / over-priced?