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.

Short answer

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

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	$57.05	$54
Travel Packs	$0.815	$1.8

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

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.