MA – L2 – Q3 – Activity-Based Costing

Calculate unit costs using traditional and ABC methods for three drug products, and discuss conditions for taking action on variances.

Question

a) MedSource Pharmaceuticals PLC (MedSource), an indigenous local drug manufacturing firm produces and markets three products Longlast DS, Ludicare CS and Lumback HS. The firm has noted the deficiencies in traditional overhead absorption methods and has taken the decision to introduce an activity-based costing (ABC) system in order to correctly allocate costs to their products and also enhance cost control techniques.

Traditionally, the original costing method has been to allocate overheads to products using a single indirect cost pool where overheads are allocated on the basis of direct labour hours (DLH). Using the ABC approach, MedSource will apportion indirect costs to products using cost pools which are representative of the relevant activity areas.

Relevant information relating to the three products for the next period is as follows:

	Longlast DS	Ludicare CS	Lumback HS
Units to be produced and sold	156,000	97,500	39,000
Unit direct material cost	GH¢247	GH¢234	GH¢208
Unit direct labour hours	7.8	10.4	9.1
Machine hours	5.2	10.4	11.7
Number of production runs	20	39	98
Number of component receipts	59	98	468
Number of production orders	59	39	98
Direct labour per hour	GH¢10	GH¢10	GH¢10
Variable overheads per unit	GH¢44	GH¢57	GH¢49

Estimated amounts of fixed overheads are expected to be as follows:

	GH¢’000	Cost Driver
Set up	1,638	Production runs
Machine	10,530	Machine hours
Goods inwards	3,276	Component receipts
Packaging	2,340	Production order
Engineering	2,106	Production order
Total	19,890

Required:
Calculate the unit costs of each product using:
i) Traditional Cost approach, based on direct labour hour rate.
ii) The ABC method.

b) When variances are discovered on investigation, and the cause of the variance can be controlled, action should be taken by Management.

Required:
Discuss FOUR conditions under which a responsible staff would take action to ensure the variances are controlled.

Answer

a) Unit Cost Using Traditional Approach
i)

$Material Labour Variable Overhead Overhead Unit cost Longlast DS GH¢ 247784460429 Ludicare CS GH¢ 2341045780475 Lumback HS GH¢ 208914970418$

(ii) Unit cost using ABC approach

$Material Labour Variable Overhead Overhead Unit cost Longlast DS GH¢ 247784437.899406.899 Ludicare CS GH¢ 2341045770.516465.516 Lumback HS GH¢ 2089149204.621552.621$

Alternative presentation (ABC)

$Set-up Machine use Goods inwards Packaging Engineering Total Prime cost Longlast DS GH¢ 1.3424.021.984.524.0635.92369.00404.92 Ludicare CS GH¢ 4.1748.055.224.784.3066.57395.00461.57 Lumback HS GH¢ 26.2254.0562.9030.0027.00200.17348.00548.17$

Workings:

Total budgeted overhead	GH¢19,890,000
Longlast DS	7.8 x 156000	1,216,800 hrs
Ludicare CS	10.4 x 97500	1,014,000hrs
Lumback HS	9.1 x 39000	354,900hrs
		2,585,700hrs

Direct labour hour rate = $2 , 585 , 700 h o u rs G H ¢19 , 890 , 000$ = GH¢7.70 per hour

	Longlast DS	Ludicare CS	Lumback HS
Direct labour hours per unit	7.8	10.4	9.1
Labour cost at GH¢10 per hour	78	104	91
Direct labour hour rate	7.7	7.7	7.7
Unit overhead cost	60.06	80.08	70.07

Total activity volumes:

	Quantity	Direct labour	Material Cost	Machine hours	Component Receipts	Production run	Production order
Longlast DS	156,000	1,216,800	38,532,000	811,200	59	20	59
Ludicare CS	97,500	1,014,000	22,815,000	1,014,000	98	39	39
Lumback HS	39,000	354,900	8,112,000	456,300	468	98	98
	Total	2585700	69459000	2281500	625	157	196

Cost driver rates

Activity	Allocated overheads GH¢	Cost Driver	Activity per period	Overhead absorption rate (OAR)
Set up	1,638,000	Production runs	157	10,433
Machine	10,530,000	Machine hours	2,281,500	5
Goods inwards	3,276,000	Component receipts	625	5,242
Packaging	2,340,000	Production order	196	11,939
Engineering	2,106,000	Production order	196	10,745
Total	19,890,000

Overhead cost per unit using ABC Approach

Activity	Cost driver rate	Longlast DS	Ludicare CS	Lumback HS	Total cost
		156,000	97,500	39,000
		GH¢	GH¢	GH¢	GH¢
Setup:
20 Production runs	10,433	208,660			208,660
39 Production runs	10,433		406,887		406,887
98 Production runs	10,433			1,022,434	1,022,434
Total		208,660	406,887	1,022,434	1,637,981
Machine Use
811200 Machine hrs	5	4,056,000			4,056,000
1014000 Machine hrs	5		5,070,000		5,070,000
456300 Machine hrs	5			2,281,500	2,281,500
Total		4,056,000	5,070,000	2,281,500	11,407,500
Goods inwards
59 comp. receipts	5,242	309,278			309,278
98 comp. receipts	5,242		513,716		513,716
468 comp. receipts	5,242			2,453,256	2,453,256
Total		309,278	513,716	2,453,256	3,276,250
Packaging
59 Production orders	11,939	704,401			704,401
39 Production orders	11,939		465,621		465,621
98 Production orders	11,939			1,170,022	1,170,022
Total		704,401	465,621	1,170,022	2,340,044
Engineering
59 Production orders	10,745	633,955			633,955
39 Production orders	10,745		419,055		419,055
98 Production orders	10,745			1,053,010	1,053,010
Total		633,955	419,055	1,053,010	2,106,020
TOTAL		5,912,294	6,875,279	7,980,222	20,767,795
OVERHEAD COST PER UNIT		37.899	70.516	204.621

b) Conditions under which a responsible staff would take action to ensure the variances are controlled:

If the variance is material enough to significantly impact financial statements, key performance indicators, or overall business objectives, it warrants attention and corrective action. A small, insignificant variance might be acceptable, but a material variance should always be investigated and addressed.
If the variance is a recurring issue, it indicates a systemic problem that needs to be resolved. A one-time deviation might be an anomaly, but a consistently occurring variance suggests a process or system flaw that requires intervention.
If the variance affects critical performance metrics that are essential to the business’s success, it should be addressed. For example, if a variance impacts production efficiency, customer satisfaction, or profitability, it needs to be controlled.
Before taking action, management should assess whether the cost of implementing corrective measures is less than the potential loss or damage caused by the variance. If the cost of fixing the problem is prohibitively high, it may be more prudent to accept the variance or find alternative solutions.

Tags: Activity-Based Costing, Cost Drivers, Management Action, Overhead Absorption, Traditional Costing, Unit Cost Calculation, Variance Analysis, Variance Control
Level: Level 2

Topic: Activity-based costing, Standard Costing, Variance Analysis
Series: JULY 2025

Uploader: Samuel Duah

MA – L2 – Q3 – Activity-Based Costing

Calculate unit costs using traditional and ABC methods for three drug products, and discuss conditions for taking action on variances.

Workings:

Total activity volumes:

Cost driver rates

Overhead cost per unit using ABC Approach

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MA – L2 – Q3 – Activity-Based Costing

Calculate unit costs using traditional and ABC methods for three drug products, and discuss conditions for taking action on variances.

Workings:

Total activity volumes:

Cost driver rates

Overhead cost per unit using ABC Approach

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