Med Supplies Company produces three different active ingredients used in medical imaging procedures in hospitals and medical clinics. The products are named as Diomycin, Homycin, and Addolin. These three products are sold in units of capsules placed inpackets. MedSupplies Company has been able to gain a competitive advantage over other players in the market since its start, five years ago, through high quality and excellent service. To assign manufacturing overhead costs to all three products, the company has used a direct labor hour-based system.

As you saw, Med Supplies Company decided to use Activity-Based Costing (ABC) which is an overhead cost allocation system that identifies the costs of various overhead activities performed in an organization and collects costs on the basis of the underlying nature and extent of those activities.

Question 1:

ABC is a useful tool, but is not necessarily appropriate for all companies, and not every traditional accounting system provides inadequate or inaccurate cost information. Discuss the two primary assumptions that underlie the use of ABC system for Med Supplies Company.