Question

Case: Cost System Considerations for CANADA SNOWCONES LTD.

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 The founder of the company, Samantha Reynolds, had originally made the yogurt in her basement.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.

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

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

Ans 1 (A)    Samantha's more traditional costing system.

Pre-determined Rate = Total overheat cost/Direct labor cost

                                 = 4500000/2000000 = $2.25

Details                                              Peanut butter bacon                               Chocolate

Direct Material                                                2.2                               1.9

Direct Labor                                                    1.4                               1.4

OH-peanut butter bacon = 2.25 P.R x 1.4/GL                        3.15                             3.15

OH Chocolate = 2.25 P.R x 1.4/GL                          

                                                Total                $6.75                           $6.45

(B) Laura's suggestion to use activity-based costing.

Answer (b): In order to find out the Rates for each activity based on the units we have to divide the budget cost of activity by the budget activity level as below:

Rate (Purchasing) = 60000/829 = $ 72.37 per order

Rate (Material Handling) = 71250/1766 = $ 40.34 per setup

Rate (Mixing) = 691500/920 = $ 99.45 per order

Rate (Chilling) = 131250/1856 = $ 70.71 per hour

Rate (Packaging) = 82500/1020 = $ 80.88 per hour

Rate (Quality Control) = 13500/206 = $ 65.53 per order

                                                PBB                                                    Chocolate

DM                                          2.2                                                       1.9

DL                                           1.4                                                       1.4

	Peanut Butter Bacon	Chocolate
Direct Material	2.2	1.9
Direct Labour	1.4	1.4
Overhead
Purchasing	1.81	0.14
(1500/40)*(72.32*1)/1500	(80000/500)*(72.38*1)*/80000
Material Handling	1.21	0.03
(1500/100)*(3*40.35)/1500	(80000/4000)*(3*40.35*1)/80000
Mixing	0.40	0.20
(0.4*99.46*1)/100	(0.2*99.46*1)/100
Chilling	1.06	1.06
(1.5*70.72*1)/100	(1.5*70.72*1)/100
Packaging	0.40	0.20
(0.5*80.88*1)/100	(0.25*80.88*1)/100
Quality Control	0.66	0.02
(1500/100)*(65.53*1)/1500	(80000/4000)*(65.53*1)/80000
Total Cost	$9.14	$4.95

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

Ø Their impact on costs for independent products.

Answer 2 (A)

· Traditional Costing: Traditional costing is the allocation of factory overhead to products based on the volume of production resources consumed. In this method, overhead is usually applied based on the amount of direct labor hours or machine hours used. The difficulty with traditional costing is that factory overhead may be higher than the basis of allocation, so that a small change in the volume of resources consumed can effect a huge change in the amount of overhead applied.

· Activity Based Costing: Activity-based costing was developed to circumvent this issue with traditional costing, using a more detailed analysis of the relationship between overhead costs and cost drivers. Many cost drivers may be used to create a better-founded allocation of overhead costs.

· Overhead in Traditional versus ABC Costing
	Traditional	ABC
Overhead assigned	Single cost driver	Multiple cost drivers
Optimal usage	When direct labor is a large portion of the product cost	When technology is a large portion of the product cost
Orientation	Cost driven	Process driven

Answer 2 B)Their effect on CSL's total firm income? (Assuming everything else remains the same, such as production and sales prices)

· Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them. CSL enables effective challenge of operating costs to find better ways of allocating and eliminating overheads. It also enables improved product and customer profitability analysis. It supports performance management techniques such as continuous improvement and scorecards.

· Costs are not intrinsically fixed or variable. ABC analysis permits managers to understand the sources of cost variability and reveals actions they can take to reduce demands on their organizational resources. Having reduced the demands, managers can then increase throughput or reduce spending to convert the savings into increased profits.

· If there are significant contrasts, why are they present? If there are

Answer 2 (c):

· Significant contrast is that in ABC using the traditional costing that allocating the random percentage for the overhead cost which means indirect cost. As the company ABC accounting would be able to know the cost of sold goods and gross margin are differ for each product.

· Non-significant contrast is the direct cost in activity based and traditional costing area assuming the same. Accountants measures the product unit cost for each direct cost category. As the costing approach is differ for both costing assigning value called indirect cost of the products. And even sometime both methods show a different view of profitability for each product.

The core issue that management wants to know is that to identify which product bring more profit and which product needs more attention that why it is in lost.

Question 3: What would you recommend being Samantha's next step, based on this analysis? Explain.

Answer 3:

Costing	Peanut Butter Bacon	Chocolate
Traditional Costing	6.75	6.45
ABC Costing	9.14	4.95

I would recommend that Samantha should use the costing method based on the activity. If Samantha use ABC method that the price of each product will calculate precisely.

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