(LO 9-1,3,5,6 9-65. Activity-Based Costing: The Grape Cola Caper Howard Rockness
ID: 2572036 • Letter: #
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(LO 9-1,3,5,6 9-65. Activity-Based Costing: The Grape Cola Caper Howard Rockness was worried. His company, Rockness Bottling, showed declining profits over the past several years despite an increase in revenues With profits declining and revenues increasing, Rockness knew there must be a problem with costs Rockness sent an e-mail to his executive team under the subject heading. "How do we get Rockness Bottling back on track?" Meeting in Rockness's spacious office, the team began brainstorming solutions to the declining profits problem. Some members of the team wanted to add products. (These were marketing people.)Some wanted to fire the least efficient work ers (These were finance people.) Some wanted to empower the workers (These people worked in the human resources department.) And some people wanted to install a new computer system. (It should be obvious who these people were) Rockness listened patiently. When all participants had made their cases, Rockness said, We made money when we were a smaller, simpler company. We have grown, added new prod- uct lines, and added new products to old product lines. Now we are going downhil. What's wrong with this picture? Rockness continued, "Here, look at this report. This is last month's report on the cola bottling line. What do you see here?" He handed copies of the following report to the people assembled in his office 1Monthly Report on Cole Bottling Line Diet Regular Cherry Grape Total $ 75.000 . $ 60,000- $13.950 $ 1,650 $ 150 600 3 Sales 4 Less: 5 Materials 25,000 10,000 4,000 20,000 8,000 3,200 4.680 1,800 720 200 80 50,230 20,000 8,000 Direct labor Fringe benefits on direct labor 8 · Indirect costs (O 260% of direct labor) 9 Gross margin 0 Return on sales (see note lap 1Volume 12 Unit price 3 Unit cost 10,000 $ 8,000 $ 2,070 $ 300$ 20,370 18.2% 135% 000100,000 $ 1.50 1.50 $ 1.55 $ 1.65 $ 1506 1.30$1.30$1.32 1.35 $ 1.302 133% 133% 0,000 40,000 9,000 15 .Return on sales before considering selling,general, and administrative expenses 16 Rockness asked, "Do you see any problems here? Should we drop any of these products? Should we reprice any of these products? The room was silent for a moment, and then everybody started talking at once. Nobody could see any problems based on the data in the report, but they all made suggestions to Rockness ranging from "add another cola product" to "eut costs across the board" to "we need a new computer system so that managers can get this information more quickly." A not-so-patient Rockness stopped the discussion abruptly and adjourned the meeting He then turned to the quietest person in the room--his son, Rocky-and said, "I am suspicious of these cost data, Rocky Here we are assigning indirect costs to these products using a 260 percent rate. I really wonder whether that rate is accurate for all products I wantExplanation / Answer
Cost driver &total volume Indirect labor Information technology Fringe benefits on indirect labor Machinery depreciation Machinery maintenance Set-ups 560 Labor hrs. 50% 50% Production runs 110 Prodn.runs 40% 80% 40% No.of products 4 Products 10% 20% 10% M/c hr. capacity 10000 hrs. 100% 100% a. Cost driver rate calculation: Cost driver &total volume Indirect labor Information technology Fringe benefits on indirect labor Machinery depreciation Machinery maintenance Energy Total cost for the activity Total cost/activity volume=Cost/activity Per Set-ups 560 Labor hrs. 10000 5000 15000 560 26.79 Labor hr. Production runs 110 Prodn.runs 8000 6400 4000 18400 110 167.27 Prodn.run No.of products 4 Products 2000 1600 1000 4600 4 1150 Product M/c hr. capacity 10000 hrs. 8000 4000 2000 14000 10000 1.4 hr. Total cost 20000 8000 10000 8000 4000 2000 52000 b. Unit cost Diet Regular Cherry Cola Grape Cola Total Set-ups 200*26.79= 5358 60*26.79= 1607.4 240*26.79= 6429.6 60*26.79= 1607.4 15002.4 Production runs 40*167.27= 6690.8 30*167.27= 5018.1 30*167.27= 5018.1 10*167.27= 1672.7 18399.7 No.of products 1150 1150 1150 1150 4600 M/c hr. capacity 5000*1.4= 7000 4000*1.4= 5600 900*1.4= 1260 100*1.4= 140 14000 Total cost 20198.8 13375.5 13857.7 4570.1 52002.1 No.of units produced 50000 40000 9000 1000 Per unit cost 20198.8/50000= 0.40 13375.5/40000= 0.33 13857.7/9000= 1.54 4570.1/1000= 4.57 Total cost/no.of units c. Monthly Report on Cola Bottling Line Diet Regular Cherry Grape Total Sales 75000 60000 13950 1650 150600 Less: Materials 25000 20000 4680 550 50230 Direct labor 10000 8000 1800 200 20000 Fringe benefits on D/L 4000 3200 720 80 8000 Indirect cost (as per ABC) 20198 13375 13857 4570 52000 Gross Margin 15802 15425 -7107 -3750 20370 Return on sales 21.07% 25.71% -50.95% -227.27% 13.53% Volume 50000 40000 9000 1000 100000 Unit Price 1.5 1.5 1.55 1.65 1.506 Unit cost 1.18 1.11 2.34 5.40 1.302 4 Diet Regular Cherry Grape Total OH allocation Before ABC 26000 20800 4680 520 52000 ABC 20198 13375 13857 4570 52000 Difference 5802 7425 -9177 -4050 0 From ABC of indirect costs, it is clear that currently, profitable product lines look less profitable & the actually loss-making ones ,do not show any loss. ABC helps to know the actual cost that goes in manufacturing a product --with the help of activities involved on the shop-floor. Also, the pricing(selling price )of Cherry & Grape colas are very low ,not even covering the basic costs. So, the management should revise both their prices ,if the market permits Or both the products need to be dropped ,as they are not contributing any additional revenue
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