Volume-Based Costing versus ABC ADA Pharmaceutical Company produces three drugs— Dio...

Volume-Based Costing versus ABC 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:

ADA has identified the following activities as cost drivers and has allocated them to total overhead cost of $200,000 as follows:

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.

SUPERVISION OF DIRECT LABOR: Supervisors spend their time supervising production. The amount of time they spend on each product is proportional to the direct labor-hours worked.

QUALITY INSPECTION: 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:

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.

3. The two cost systems provide different results; give several reasons for this. Why might these differences be strategically important to ADA Pharmaceutical? How does ABC add to ADA’s competitive advantage?

4. How and why may firms in the pharmaceutical industry use ABC? What is the strategic advantage?