Question

Canada Snowcones Ltd. (CSL) owned and operated 20 retail frozen yogurt stores spread throughout Southern Ontario, from Toronto to Windsor. CSL's stores sold only high quality, premium frozen yogurt. They offered an assortment of 35 different frozen yogurt flavours. A significant amount of the CSL flavours were special, such as "Peanut Butter Bacon", "Charcoal-Sushi", and "Tropical Cheese Sensations". However, CSL also sold a few of the classic frozen yogurt flavours, such as vanilla, milk chocolate, mint, and other singular fruit flavours. While some of the flavours were very popular, there were also some of the more peculiar flavours that had low total sales in terms of units.

CSL produced its own frozen yogurt. The founder of the company, Samantha Reynolds, had originally made the yogurt in her basement. But eventual growing demand led to Samantha renting part of factory for CSL's production. As CSL grew, Samantha was able to afford automated but more costly production equipment that blended the flavours and packaged the liquid frozen yogurt for freezing. CSL's most significant production costs were for raw materials, particularly yogurt, brown sugar, and the special flavour ingredients, and for the purchase, operation, and maintenance of production equipment.

All of CSL's products had the same retail price, as customers could choose or combine any flavours by scoops. Samantha set the prices to generate, on average, a markup of 100% on average full production costs. CSL's 2019 budget included manufacturing overhead (MOH) of $450,000. To estimate product costs, Samantha spread this MOH cost to products based on a proportion of the direct labour (DL) costs used in the production process. CSL's total DL costs for 2019 was $200,000, so Samantha charged the overhead to products at a rate of MOH to total DL costs.

Last week, Laura Horton, Samantha's babysitter for her daughter and the CEO of a large production firm, advised that Samantha's pricing strategy was not optimal. Laura's insight was that the expenses for producing CSL's numerous flavours were not uniform. She thought those inconsistencies should be reflected in the prices charged, or CSL's earnings would fluctuate as the combination of flavours sold varied.

Laura proposed that Samantha reestimate product costs using activity-based costing. She recommended that Samantha identify the major activities whose costs were included in the company's MOH costs. Then, she should apply these costs to products based on the products consumption of each of those activities. In response to Laura's suggestions, Samantha prepared the information presented below in Table 1.

Samantha decided to hire your consulting firm to help calculate the costs of two demonstrative flavours as an experiment to see if Laura's activity based costing system suggested produced any significant contrasts. She asked Laura to take her best estimate as to where she might find the most material differences, if any existed. After Samantha described the products to her, Laura suggested that she use Peanut Butter Bacon and Chocolate as the test product examples. Table 2 provides data relevant to the two selected products.

Table 1 Activity Purchasing Material Handling Mixing Chilling Packaging Quality Control Total MOH costs Canada Snowcones Ltd. - Budgeted MOH Costs Budgeted Cost (5000) Driver $ 60,000 Purchase Orders $ 71,250 Number of setups $ 91,500 Mixing hours $ 131,250 Chilling hours $ 82,500 Packaging machine hours $ 13,500 Number of batches $ 450,000 Budgeted Activity Level 829 1,766 920 1,856 1,020 205 Table 2 Canada Snowcones Ltd. - Two Product Examples Peanut Butter Bacon Direct Material (DM) $ 2.20 per gallon Direct Labour (DL) $ 1.40 per gallon Budgeted Production and sales 1,500 gallons Size of Batch 100 gallons Number of setups 3 per batch Size of Purchase Order 40 gallons Time in mixer 0.40 hour per 100 gallons Time in chiller 1.50 hour per 100 gallons Time in package machine 0.50 hour per 100 gallons Chocolate $ 1.90 per gallon $ 1.40 per gallon 80,000 gallons 4,000 gallons 3 per batch 500 gallons 0.20 hour per 100 gallons 1.50 hour per 100 gallons 0.25 hour per 100 gallons

Case Questions

1.      Utilizing the information above, calculate the full product cost (on a per gallon basis) of the Peanut Butter Bacon and Chocolate flavours utilizing:

a.      Samantha's more traditional costing system.

b.      Laura's suggestion to use activity-based costing.

2.      What are the impacts, if there is any at all, of switching CSL's costing method? In particular, are the any significant contrasts between traditional costing and activity-based costing in terms of:

a.      Their impact on costs for independent products.

b.      Their effect on CSL's total firm income? (assuming everything else remains the same, such as production and sales prices)

c.       If there are significant contrasts, why are they present? If there are no significant contrasts, why are they not present?

3.      What would you recommend to be Samantha's next step, based on this analysis? Explain.

Answer 1

1.(A) SAMANTHA'S TRADITIONAL COST SYSTEM

WN-1

Overhead Absorption rate=Total Manufacturing Overheads/Direct Labor Cost=$45000/$20000=2.25

which essentially means that overhead cost is 2.25 times the labor cost.

Particulars	Peanut Butter	Chocolate
1.Production and sales (in gallons)	1500	80000
2.Direct Material	$2.2*1500=$3300	$1.9*80000=$152000
3.Direct labor	$1.4*1500=$2100	$1.4*80000=$112000
4.Absorbed Manufacturing Overheads(2.25*3 above)	$2100*2.25=$4725	$112000*2.25=$252000
5.Total Product cost (2 to 4)	$10125	$516000
6.Total Cost per gallon	$6.75	$6.45

(B) LAURA'S SUGGESTION TO USE ACTIVITY BASED COSTING

Activity	Cost Driver	Total Cost(in $)(1)	Cost per Cost Driver (1/cost driver)
1.Purchasing	Purchase orders	60000	60000/829=72.38 per purchase order
2.Material handling	Number of setups	71250	71250/1766=40.34 per setup
3.Mixing	Mixing hours	91500	91500/920=99.46 per mixing hour
4.Chilling	Chilling hours	131250	131250/1856=70.72 per chilling hour
5.Packaging	Packaging Machine hours	82500	82500/1020=80.88 per machine hour
6.Quality Control	Number of batches	13500	13500/206=65.53 per batch
7.Total (1 to 6)		450000

Product cost for Peanut Butter and Chocolate

Particulars	Peanut Butter	Chocolate
1.Units Produced and Sold (in gallons)	1500	80000
2.Direct Materials(from (A))	3300	152000
3.Direct Labor(from (A))	2100	112000
4.Manufacturing Overheads
Purchasing	$72.38*(1500/40)=2714.25	$72.38*(80000/500)=11580.8
Material handling	$40.34*[1500/100]*3=1815.3	$40.34*[80000/4000]*3=2420.4
Mixing	$99.46*[1500/100]*0.4=596.76	$99.46*[80000/100]*0.2=15913.6
Chilling	$70.72*[1500/100]*1.5=1591.2	$70.72*[80000/100]*1.5=84864
Packaging	$80.88*[1500/100]*0.5=606.6	$80.88*[80000/100]*0.25=16176
Quality Control	$65.53*[1500/100]=982.95	$65.53*[80000/4000]=1310.6
Total	8307.06	132265.4
5.Total Product Cost(2 to 4)(rounded off)	13707	396265
6.Total Product Cost per gallon	$9.138	$4.953

2.

(A) There is an impact on the product cost, using traditional cost system and activity based cost system

Particulars	Traditional	Activity Based	Difference
Peanut Butter	$6.75	$9.138	increased by $2.388
Chocolate	$6.45	$4.953	decreased by $1.497

As per traditional system the product with higher cost , peanut butter is actually shown as the product with lower cost;while the product with low cost,Chocolate is shown as the product with higher cost.

(B) It will impact the profit to the company only to the extent of differences in the absorption of the overheads.

(C) They are significant differences between the traditional and Activity based system of costing, whilst Traditional system is volume based, which is not a great parameter when the entity has more than one product and are different.

In the given case the company has to use activity based costing system as it gives true results with regard to an entity that has multiple heterogenous products and also the production is machine based.

As the cost ascertainment is based on different activities involved in producing the product and not based on some single overhead absorption rate the true effects are made to the product cost.

3.

Samantha has to introsuce and implement Activity based cost system to her entity based on specific quality of her entity's operations and products.