Q33PGA_4 - Horngren'S Financial And Managerial Accounting

Question

Willitte Pharmaceuticals manufactures an over-the-counter allergy medication. The company sells both large commercial containers of 1,000 capsules to health care facilities and travel packs of 20 capsules to shops in airports, train stations, and hotels. The following information has been developed to determine if an activity-based costing system would be beneficial:

Activity                          Estimated                                             Estimated Quantity

                                     Indirect Cost          Allocation Base      of Allocation Base

Materials handling          \( 95,000        Number of kilos                    19,000 kilos

Packaging                         200,000        Number of machine hours   5,000 hours

Quality assurance            112,500        Number of samples             1,875 samples

Total indirect costs       \) 407,500

Actual production information includes the following:

                                               Commercial Containers                  Travel Packs

Units produced                            2,400 containers                       50,000 packs

Weight in kilos                             9,600                                            5,000

Machine hours                             1,680                                               500

Number of samples                        240                                               750

Requirements

4. Compare the indirect activity-based costs per unit to the indirect costs per unit from the traditional system. How have the unit costs changed? Explain why the costs changed.

Step-by-Step Solution

Answer

The traditional method allocated costs on a uniform basis but the activity method allocates them based on the activity and predetermined rate for them. So, there would be a difference in unit cost between the two methods.

Step 1: Comparison of indirect cost per unit by activity-based method and traditional method

By comparing the figures, it can be noticed that the indirect cost per unit is highest under activity-based costing.

Step 2: Why unit cost changed under both methods

There is a difference between the unit cost under both methods. The reason is that under the traditional method the cost is allocated based on a uniform allocation basis. So, this system may not allocate costs fairly and some products or processes may be charged with higher costs. 

But under the activity-based method, first of all, indirect costs are segregated into different activities, and then diffract activities’ costs are allocated based on some allocation base. In this, each product or process is charged with a fair amount of cost and there is less chance of having a larger disparity among product costs. 

This is the reason for the unit cost change under both methods.