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

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ADA Pharmaceutical Company produces three drugsDiomycin, Homycin, and Addolinbelonging to the analgesic (pain-killer) family of medication. Since its inception four years ago, ADA has used a direct labor hourbased 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 firms current costing and activity-based costing systems.

ADA has the following budget information for the year:

	Diomycin				Homycin				Addolin
Cost of direct materials	$	203,000			$	263,000			$	256,000
Cost of direct labor		248,000				232,000				261,000
Number of direct labor hours		7,180				6,780				1,980
Number of capsules		980,000				498,000				298,000

ADA has identified the following activities and cost drivers and has assigned them a total overhead cost of $199,000.

Activity	Cost Driver	Budgeted Overhead Cost				Budgeted Cost Driver Volume
Machine setup	Setup hours	$	15,800				1,580
Plant management	Number of Workers		35,800				1,180
Supervision of direct labor	Direct labor hours		45,800				15,800
Quality inspection	Inspection hours		50,200				1,040
Order expediting	Customers served		51,400				635
Total overhead		$	199,000

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		190				590				790
Number of workers		190				390				590
Direct labor hours		7,180				6,780				1,980
Inspection hours		140				190				690
Customers served		43				98				490

rev: 09_27_2018_QC_CS-140513

Part 1

Required:

1. Use the firms 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.

	Diomycin	homycin	addolin
direct materials	203,000	263,000	256,000
direct labor	248,000	232,000	261,000
overhead
total cost	451,000
packets produced	980,000	498,000	298,000
cost per capsule