Question

Mercia Chocolates produces gourmet chocolate products with no preservatives. Any production must be sold within a few days, so producing for inventory is not an option. Mercia’s single plant has the capacity to make 98,000 packages of chocolate annually. Currently, Mercia sells to only two customers: Vern’s Chocolates (a specialty candy store chain) and Mega Stores (a chain of department stores). Vern’s orders 62,600 packages and Mega Stores orders 23,000 packages annually. Variable manufacturing costs are $26 per package, and annual fixed manufacturing costs are $618,000.

The gourmet chocolate business has two seasons, holidays and non-holidays. The holiday season lasts exactly four months and the non-holiday season lasts eight months. Vern’s orders the same amount each month, so Vern’s orders 19,800 packages during the holidays and 42,800 packages in the non-holiday season. Mega Stores only carries Mercia’s chocolates during the holidays.

Required:

a. Calculate the product cost for each season with excess capacity costs assigned to season in which it is incurred.

b. Calculate the product cost for each season with excess capacity costs assigned to the season requiring it.

Answer 1

With seasonal demand fluctuations, the reason for the excess capacity is for the benefit of the two customers. The issue is how to treat the excess capacity costs.
Capacity costs in holiday season = ($618,000/12) * 4 = $206,000

Capacity costs in non holiday season ($618,000/12) * 8 = $412,000

Two approaches to costing are:

a. Excess capacity costs assigned to season in which it is incurred, then to products in that season:

Holiday:

Overhead rate = $206,000/42,800 packages = $4.81 per package

Product cost = $26 + $4.81 = $30.81 per package

Non Holiday:

Overhead rate = $412,000/42,800 packages = $9.63 per package

Product cost = $26 + $9.63 = $35.63 per package

b. Excess capacity costs assigned to the season requiring it, then to products produced during that season:

Since the number of packages required in each season is equal, capacity cost required should also be equal:

Capacity costs each season = $618,000/2 = $309,000

Holiday:

Overhead rate = $309,000/42,800 packages = $7.22 per package

Product cost = $26 + $7.22 = $33.22 per package

Non holiday:

Overhead rate = $309,000/42,800 packages = $7.22 per package

Product cost = $26 + $7.22 = $33.22 per package