3. MEMO TO THE PRESIDENT: Analysis of JSI’s data shows that several
activities other than direct labor drive the company’s manufacturing
overhead costs. These activities include purchase orders issued, number
of setups for material processing, and number of batches processed.
The company’s present costing system, which relies on direct labor time
as the sole basis for assigning overhead cost to products, significantly
undercosts low-volume products, such as the Viet Select coffee, and
significantly overcosts high-volume products, such as our Kenya Dark
coffee.
An implication of the activity-based costing analysis is that our low-
volume products may not be covering the costs of the manufacturing
resources they use. For example, Viet Select coffee is currently priced at
$5.03 per pound ($4.02 plus 25% markup), but this price is below its
activity-based cost of $5.08 per pound. Under our present costing and
pricing system, our high-volume products, such as our Kenya Dark cof-
fee, may be subsidizing our low-volume products. Some adjustments in
prices may be required. However, before taking such an action, an ac-
tion analysis report (discussed in Appendix 8A) should be prepared.
Case 8-31 (continued)
ALTERNATIVE SOLUTION:
Most students will compute the manufacturing overhead cost per pound
of the two coffees as shown above. However, the per pound cost can
also be computed as shown below. This alternative approach provides
additional insight into the data and facilitates emphasis of some points
made in the chapter.
Kenya Dark Viet Select
Total Per Pound
(÷ 80,000) Total Per Pound
(÷ 4,000)
Purchasing... $ 1,120 $0.014 $2,240 $0.560
Material handling.... 6,176 0.077 3,088 0.772
Quality control ... 2,880 0.036 1,440 0.360
Roasting ... 13,200 0.165 660 0.165
Blending ... 2,400 0.030 120 0.030
Packaging... 1,200 0.015 60 0.015
Total ... $26,976 $0.337 $7,608 $1.902
Note particularly how batch size impacts unit cost data. For example,
the cost to the company to process a purchase order is $280, regardless
of how many pounds of coffee are contained in the order. Twenty thou-
sand pounds of the Kenya Dark coffee are purchased per order (with
four orders per year), and just 500 pounds of the Viet Select coffee are
purchased per order (with eight orders per year). Thus, the purchase
order cost per pound for the Kenya Dark coffee is just 1.4 cents,
whereas the purchase order cost per pound for the Viet Select coffee is
40 times as much, or 56 cents. As stated in the text, this is one reason
why unit costs of low-volume products, such as the Viet Select coffee,
increase so dramatically when activity-based costing is used.
Case 8-32 (90 minutes)
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