Q39PGB_4 - Horngren'S Financial And Managerial Accounting

Question

Harcourt 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           \( 96,000     Number of kilos                      24,000 kilos

Packaging                          210,000      Number of machine hours      3,000 hours

Quality assurance             114,000       Number of samples             1,900 samples

Total indirect costs        \) 420,000

 

Other production information includes the following:

                                            Commercial Containers                   Travel Packs

Units produced                          2,800 containers                       51,000 packs

Weight in kilos                            9,800                                           5,100

Machine hours                            1,960                                              510

Number of samples                      560                                              765

 

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 as they did.

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

	Indirect cost per unit
	By Traditional Method	By Activity-based method
Commercial containers	$98	$75
Travel Packs	$1.4	$2

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.