The California Cooking Oil Company (CCO) has been using machine-hours as the bas

Question

The California Cooking Oil Company (CCO) has been using machine-hours as the basis to determine overhead costs for all products. An ABC project team points out that the firm manufactures several products, each of which uses significantly different factory supporting resources. As a start, the team suggests the following overhead cost pools, cost drivers, and estimated cost driver levels for manufacturing overheads: CCO has recently completed production of 600 barrels each of P5 and G23. P5 is a corn- based oil distributed primarily through supermarkets. G23 is made from olive oil, flaxseed oil, and other exotic ingredients and sold to up-scale restaurants as a gourmet food. The productions require the following operations: Determine the overhead costs per barrel of P5 and G23 using the current single cost driver system based on machine-hours. 2. Determine the overhead costs per barrel of P5 and G23 using the multiple cost driver system suggested by the ABC project team. 3. Explain how the choice of costing system can be an important competitive factor for CCO. How can the costing system help the firm become more profitable and competitive?

Explanation / Answer

Other OH costs

Other OH costs

Other OH costs

No of Cost drivers for 600 barrels OH Cost Pool Cost Driver Estimated cost driver level Budgeted Overhead OH cost /cost driver level P5 G23 Machine set ups No of set ups                        120      80,000          667               3              45 Materials handling No Of Barrels                  12,000 120,000            10          600           600 Quality control No Of inspections                    1,300 240,000          185               4              16

Other OH costs

Machine hours                    8,500 100,000            12      1,250        1,250 Total 540,000 Single cost driver system Total Machine hrs                          8,500 Total Overheads                      540,000 Overheads/Machine Hour 63.53 1 P5 G23 Machine hrs for 600 barrels 1250                    1,250 Overheads for 600 Barrels                  79,411.76            79,411.76 Overheads per barrel                        132.35                  132.35 No of Cost drivers for 600 barrels Overheads for 600 barrels Overheads cost per barrel OH Cost Pool Cost Driver OH cost /cost driver level P5 G23 P5 G23 P5 G23 Machine set ups No of set ups                        667                3            45      2,000     30,000           3.33         50.00 Materials handling No Of Barrels                          10            600          600      6,000        6,000         10.00         10.00 Quality control No Of inspections                        185                4            16          738        2,954           1.23           4.92

Other OH costs

Machine hours                          12        1,250      1,250    14,706     14,706         24.51         24.51 Total    23,444     53,660         39.07         89.43 Overheads cost per barrel OH Cost Pool P5 G23 Machine set ups                             3.33                    50.00 Materials handling                          10.00                    10.00 Quality control                             1.23                       4.92

Other OH costs

                         24.51                    24.51 Total                          39.07                    89.43 3 It is clear from the example that the old system of OH allocation is not very accurate as it distributes OH on a single bais. ABC system on the other hand shows more accuracy in OH cost distribution as it follows the actual consumption of resources and shows a better estimate of productwise profitability. CCO can greatly improve it competitiveness as it can prceisely find productwise costs and accordingly make a better pricing decision for each product. Also CCO can make precise efforts in improving the profitability by attacking the areas where more resource is getting consumed

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