Question

Bonita Corporation produces two grades of non-alcoholic wine from grapes that it buys from California growers. It produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called CoolDay. It sells this in 600,000 5-liter jugs. Bonita also produces and sells roughly 300,000 liters per year of a low-volume, high-cost product called Lite Lite Mist is sold in 1-liter bottles. Based on recent data, the CoolDay product has not been as profitable as Lite Mist. Management is considering dropping the inexpensive CoolDay line it can focus more attention on the Lite Mist product. The Lite Mist product already demands considerably more attention than the CoolDay line. Jack Eller, president and founder of Bonita, is skeptical about this idea. He points out that for many decades the company produced only the CoolDay line and that it was always quit profitable. It wasn't until the company started producing the more complicated Lite Mist wine that the profitability of CoolDay declined. Prior to the introduction of LiteMist, the comp had basic equipment, simple growing and production procedures, and virtually no need for quality control. Because LiteMist is bottled in 1-liter bottles, it requires considerably more and effort, both to bottle and to label and box than does CoolDay. The company must bottle and handle 5 times as many bottles of Lite Mist to sell the same quantity as CoolDay. CoolDay requires 1 month of aging; Lite Mist requires 1 year. CoolDay requires cleaning and inspection of equipment every 10,000 liters; Lite Mist requires such maintenance every 6 liters. Jack has asked the accounting department to prepare an analysis of the cost per liter using the traditional costing approach and using activity-based costing. The following informati was collected. Direct materials per liter Direct labor cost per liter Direct labor hours per liter Total direct labor hours CoolDay $0.40 $0.50 0.04 120,000 Lite Mist $1.20 $0.90 0.07 21,000 Estimated Use of Cost Drivers per Product Cost Drivers Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Cart of grapes Total months Number of bottles Number of bottles Number of inspections Estimated Overhead $147,022 699,600 280,800 214,200 244,800 $1,586,422 Estimated Use of Cost Drivers 6,600 6,600,000 900,000 900,000 CoolDay 6,000 3,000,000 600,000 600,000 350 Lite Mist 600 3,600,000 300,000 300,000 450 800 Answer each of the following questions.

Answer 1

Overhead rate = Total overheads/Total labor hours	11.25121986	per hour
Calculation of manufacturing cost:
	CoolDay	LiteMist
Direct materials per liter	0.4	1.2
Direct labor cost per liter	0.5	0.9
Overhead Cost = Cost per hour*Labor hours per unit	0.450	0.788
Total Manufacturing Cost per litre	1.350	2.888
(b)Schedule showing computation of rates:
Overhead	Cost	Driver	Rate/Activity
Grape processing	147,022	6,600	22.276
Aging	699,600	6,600,000	0.106
Bottling and corking	280,800	900,000	0.312
Labeling and boxing	214,200	900,000	0.238
Maintain and inspect equipment	244,800	800	306
(c)Allocation of cost
Overhead	Rate/Activity	Activity- CoolDay	Cost Assigned	Activity-LiteMist	Cost Assigned
Grape processing	22.276	6,000	133,656	600	13,366
Aging	0.106	3,000,000	318,000	3,600,000	381,600
Bottling and corking	0.312	600,000	187,200	300,000	93,600
Labeling and boxing	0.238	600,000	142,800	300,000	71,400
Maintain and inspect equipment	306	350	107,100	450	137,700
		Total	888,756		697,666
		Number of litres	3,000,000		300,000
		Cost per litre	0.296252		2.32555
(d)Total Manufacturing cost:
	CoolDay	LiteMist
Direct materials per liter	0.4	1.2
Direct labor cost per liter	0.5	0.9
Overhead Cost	0.296	2.326
Total Manufacturing Cost per litre	1.196	4.426

e.ABC uses different overhead allocation rates which better represent the true pattern of consumption of resources and hence is a better method of cost allocation. It represents the actual cost incurred on products and should be used to evaluate profitability and for analysis. Traditional costing so not represent true consumption of resources and rather uses a single rate for allocation and thereby distorts cost information leading to poor decisions.