Question

DavidsTea is a distributor and processor of different tea blends. The company buys raw tea leaves from around the world and gently roasts, blends and packages them for resale. DavidsTea currently has over 30 different blends of gourmet teas that it sells to retail shops in one-kilogram bags. The major cost is raw materials; however, there is a substantial amount of manufacturing overhead in the predominantly automated roasting and packaging process. The company uses relatively little direct labour.

Some of the tea blends are very popular and sell in large volumes, while a few newer blends have very low volumes. DavidsTea prices its tea at full product cost, including allocated overhead, plus a markup of 30 percent. If prices for certain teas are significantly higher than market, adjustments are made. The company competes primarily on the quality of its products, but customers are price conscious as well.

Data for the 2020 budget include manufacturing overhead of $3,000,000 which has been allocated based on each product’s direct-labour costs. The budgeted direct-labour cost for 2020 totals $600,000.

The expected prime costs for one-kilogram bags of two of the company’s products are as follows:

	Green Seduction Blend	Yuzu Matcha Blend
Direct Materials	$3.20	$4.20
Direct Labour	.30	.30

DavidsTea’s controller believes the traditional product-costing system may be providing misleading cost information. She has developed an analysis of the 2020 budgeted manufacturing-overhead costs shown in the following chart.

Activity	Cost Driver	Budgeted Activity	Budgeted Cost
Purchasing	Purchase orders	1,158	$579,000
Material-handling	Setups	1,800	720,000
Quality control	Batches	720	144,000
Roasting	Roasting hours	96,100	961,100
Blending	Blending hours	33,600	336,000
Packaging	Packaging hours	26,000	260,000
Total manufacturing-overhead cost			$3,000,000

Data regarding the 2020 production of the Green Seduction Blend and the Yuzu Matcha Blend are shown in the following table. There will be no raw-material inventory of these teas at the beginning of the year.

	Green Seduction Blend	Yuzu Matcha Blend
Budgeted Sales	2,000 kg	100,000 kg
Batch size	500 kg	10,000 kg
Setups	3 per batch	3 per batch
Purchase order size	500 kg	25,000 kg
Roasting time	1 hour per 100 kg	1 hour per 100 kg
Blending time	0.5 hours per 100 kg	.5 hour per 100 kg
Packaging time	0.1 hours per 100 kg	.1 hour per 100 kg

Required:

1. Using DavidsTea’s current costing system:
   1. Determine the company’s predetermined overhead rate using direct-labour cost as the single cost driver.
   2. Determine the full product costs and selling prices of one kilogram of Green Seduction Blend and one kilogram of Yuzu Matcha blend.

2. Develop a new product cost, using an Activity Based Costing (ABC) approach, for one kilogram of the two different blends of tea.

3. What are the implications of the ABC system with respect to
   1. The use of direct labour as a basis for applying overhead to products?
   2. The use of the existing product-costing system as the basis for pricing?

Answer 1