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ABC team at Drugs 'R Us, a pharmaceutical company

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An ABC team at Drugs 'R Us, a pharmaceutical company, identified these data for a typical month:

Activity Activity
Cost in a Volume in a
Activity/Resource Cost-Driver Base Typical Month Typical Month
1. Unit Level
1.1 Acquire and use material Number of units $ 60,000 1,000,000 units
for Product A produced
1.2 Acquire and use direct labor Number of direct-labor 20,000 2,000 direct
For Product A hours worked labor hours
1.3 Acquire and use material Number of units 80,000 800,000 units
for Product B produced
1.4 Acquire and use direct labor Number of direct-labor 30,000 2,000 direct
For Product B hours worked labor hours
2. Batch Level
2.1 Quality control Number of batches 30,000 100 batches
3. Product Level
3.1 Provide product-level advertising Number of promotions 100,000 100 promotions
3.2 Provide product-level records Number of products 20,000 2 products
4. Customer Level
4.1 Take customer product orders Number of customer 40,000 2,000 customer
orders orders
4.2 Deal with customer complaints Number of complaints 20,000 1,000 complaints
5. Facility Level
5.1 Supervise direct labor Amount of direct-labor 10,000 $50,000
Costs activities 1.2 and
1.4 (supervision
costs _ 20% of
direct labor costs.)
5.2 Use main building Number of square feet 40,000 10,000 square
feet
The company's management wants you to compute the total cost and unit cost of each product for the
month of July, which had the following level of activities:
Product A Product B
1.1 and 1.3 Material 800,000 units 900,000 units
1.2 and 1.4 Direct labor 1,600 hours 2,100 hours
2.1 Quality control?batches 50 batches 40 batches
3.1 Advertising projects?promotions 50 promotions 40 promotions
3.2 Products recorded 1 product 1 product
4.1 Customer orders 800 customer orders 900 customer orders
4.2 Customer complaints 600 complaints 300 complaints
5.1 Direct-labor supervision $16,000 $31,500
5.2 Main building use 6,000 sq. ft. 3,000 sq. ft.

Required
a. Compute the cost-driver rate for each cost-driver base.

b. Use ABC to compute the cost of each of the two products given the activity level for the month of July. Compute both the total cost and unit cost for each product for the month of July.

c. Assume that the company's traditional costing system had assigned overhead costs at a rate of $.10 per unit of output plus $20.00 per direct-labor hour. Overhead costs are the sum of the batch-level, product-level, customer-level, and facility-level costs. Using this traditional costing approach, compute the cost of each product (including material and direct-labor costs) given the activity level for the month of July. Compute both the total cost and unit cost for each product for the month of July.

d. Do the unit costs of the two products computed under ABC and traditional costing systems differ significantly? If so, what causes the differences?

See attached file for full problem description.

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Solution Summary

This solution is comprised of a detailed explanation to compute the cost-driver rate for each cost-driver base, use ABC to compute the cost of each of the two products given the activity level for the month of July, compute both the total cost and unit cost for each product for the month of July, compute both the total cost and unit cost for each product for the month of July, and answer do the unit costs of the two products computed under ABC and traditional costing systems differ significantly and what causes the difference.

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Product Profitability and Activity-Based Costing Methodologies

Problem: 4.49 (Product Profitability)

Complete problem 4.49 in Hilton. As you complete the problem, refer to the following suggestions:
You will be calculating unit costs for products A and B using both traditional and activity-based costing methodologies.
a. When developing your activity-based costing rates, be sure to show the activity/resource, cost, volume, and rate per unit of measure.
b. Using your activity based rates, apply actual activities of products A and B to determine total cost by product and unit costs. Separate the activity/resources by unit, batch, product, customer, and facility levels.
c. Determine unit costs by using traditional costing.
d. Compare the unit costs using activity-based costing and traditional costing approaches and analyze the reason for the differences.

An ABC team at Drugs 'R Us, a pharmaceutical company, identified these data for a typical month:

Activity Activity
Cost in a Volume in a
Activity/Resource Cost-Driver Base Typical Month Typical Month
1. Unit Level
1.1 Acquire and use material Number of units $ 60,000 1,000,000 units
for Product A produced
1.2 Acquire and use direct labor Number of direct-labor 20,000 2,000 direct
For Product A hours worked labor hours
1.3 Acquire and use material Number of units 80,000 800,000 units
for Product B produced
1.4 Acquire and use direct labor Number of direct-labor 30,000 2,000 direct
For Product B hours worked labor hours
2. Batch Level
2.1 Quality control Number of batches 30,000 100 batches
3. Product Level
3.1 Provide product-level advertising Number of promotions 100,000 100 promotions
3.2 Provide product-level records Number of products 20,000 2 products
4. Customer Level
4.1 Take customer product orders Number of customer 40,000 2,000 customer
orders orders
4.2 Deal with customer complaints Number of complaints 20,000 1,000 complaints
5. Facility Level
5.1 Supervise direct labor Amount of direct-labor 10,000 $50,000
Costs activities 1.2 and
1.4 (supervision
costs _ 20% of
direct labor costs.)
5.2 Use main building Number of square feet 40,000 10,000 square
feet
The company's management wants you to compute the total cost and unit cost of each product for the
month of July, which had the following level of activities:
Product A Product B
1.1 and 1.3 Material 800,000 units 900,000 units
1.2 and 1.4 Direct labor 1,600 hours 2,100 hours
2.1 Quality control—batches 50 batches 40 batches
3.1 Advertising projects—promotions 50 promotions 40 promotions
3.2 Products recorded 1 product 1 product
4.1 Customer orders 800 customer orders 900 customer orders
4.2 Customer complaints 600 complaints 300 complaints
5.1 Direct-labor supervision $16,000 $31,500
5.2 Main building use 6,000 sq. ft. 3,000 sq. ft.

Required
a. Compute the cost-driver rate for each cost-driver base.

b. Use ABC to compute the cost of each of the two products given the activity level for the month of
July. Compute both the total cost and unit cost for each product for the month of July.

c. Assume that the company's traditional costing system had assigned overhead costs at a rate of $.10
per unit of output plus $20.00 per direct-labor hour. Overhead costs are the sum of the batch-level,
product-level, customer-level, and facility-level costs. Using this traditional costing approach, compute
the cost of each product (including material and direct-labor costs) given the activity level for
the month of July. Compute both the total cost and unit cost for each product for the month of July.

d. Do the unit costs of the two products computed under ABC and traditional costing systems differ
significantly? If so, what causes the differences?

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