Question

Bronson Shrimp Farms, in Brewton, Alabama, has a Processing Department that processes raw shrimp into two products:

Headless shrimp

Peeled and deveined shrimp

Bronson recently submitted bids for two orders (1) headless shrimp for a cruise line and (2) peeled and deveined shrimp for a restaurant chain. Bronson won the first bid but lost the second. The production and sales managers are upset. They believe that Bronson’s state-of-the-art equipment should have given the company an edge in the peeled and deveined market. Consequently, production managers are starting to keep their own sets of product cost records. Bronson is reexamining both its production process and its costing system. The existing costing system has been in place since 1991. It allocates all indirect costs based on direct labor hours. Bronson is considering adopting activity-based costing. Controller Heather Barefield and a team of production managers performed a preliminary study. The team identified six activities, with the following estimated indirect costs and allocation bases for the Processing Department for 2014:

Activity	Estimated Total Cost of Activity	Allocation Base
Redesigning of production process (cost of changing process and equipment)	$ 5,000	Number of design changes
Production scheduling (production scheduler salary)	6,000	Number of batches
Chilling (depreciation on refrigerators)	1,500	Weight in pounds
Processing (utilities and depreciation on equipment	19,200	Number of cuts
Packaging (indirect labor and depreciation on equipment)	1,425	Cubic feet of surface exposed
Order filling (order takers’ and shipping clerks’ wages)	7,000	Number of sales orders
Total indirect costs for the entire department	40,125

The raw shrimp are chilled and then cut. For headless shrimp, employees remove the heads, then rinse the shrimp. For peeled and deveined shrimp, the headless shrimp are further processed the shells are removed and the backs are slit for deveining. Both headless shrimp and peeled and deveined shrimp are packaged in foam trays and covered with shrink wrap. Order-filling personnel assemble orders of headless shrimp as well as peeled and deveined shrimp.

Barefield estimates that Bronson will produce 10,000 packages of headless shrimp and 50,000 packages of peeled and deveined shrimp in 2014. The two products incur the following costs and activities per package

	Costs and activities per package
	Headless shrimp	Peeled and deveined shrimp
Shrimp	$ 3.50	$ 4.50
Foam Trays	$ 0.05	$ 0.05
Shrink wrap	$ 0.05	$ 0.02
Number of cuts	1 cut	3 cuts
Cubic feet of exposed surface	1 cubic foot	0.75 cubic foot
Weight	2.5 pounds	1 pound
Direct labor hours	0.01 hour	0.05 hour

Bronson pays direct laborers $20 per hour. Barefield estimates that each product line also will require the following total resources:

	Headless shrimp (for all 10,000 packages)	Peeled and deveined shrimp (for all 50,000 packages)
Design changes	1 change	4 changes
Batches	40 batches	20 batches
Sales orders	90 orders	110 orders

1. Using the original costing system with the single indirect cost allocation base (direct labor hours), compute the total budgeted cost per package for the headless shrimp and then for the peeled and deveined shrimp. Round to two decimal places. (Hint: First, compute the predetermined overhead allocation rate. Then compute the total budgeted cost per package for each product.

2. Use activity-based costing to re-compute the total budgeted cost per package for the headless shrimp and then for the peeled and veined shrimp Round to two decimal places. (Hint: First, compute the predetermined overhead allocation rate for each activity. Then calculate the total indirect costs for (a) the entire headless shrimp product line and (b) the entire peeled and deveined shrimp product line. Next, compute the indirect cost per package for each product. Finally, calculate the total cost per package for each product)

3. Write a memo to Bronson CEO Gary Pololu explaining the results of the ABC study. Compare the costs reported by the ABC system with the costs reported by the original system. Point out whether the ABC system shifted costs towards headless shrimp or toward peeled and deveined shrimp and explain why.

Finally, explain whether Pololu should feel more comfortable making decisions using cost data from the original or from the new ABC system.

Answer 1

1. Traditional Costing:

Total direct labor hours = 10,000 packages x 0.01 hour + 50,000 packages x 0.05 hour = 2,600

Predetermined overhead allocation rate = Total Indirect Costs / Total Direct Labor Hours = $ 40,125 / 2,600 = $ 15.43 per DLH.

	Headless Shrimp	Peeled and Deveined Shrimp
Direct Material Cost	$ 3.60	$ 4.57
Direct Labor Cost	0.20	1.00
Indirect Costs	0.15	0.77
Total budgeted cost per package	$ 3.95	$ 6.34

2. Activity Based Costing :

Cost Pool	Allocation Base	Total Cost	Volume of Allocation Base	Activity Rate	Assigned to Headless Shrimp	Assigned To Peeled and Deveined Shrimp
Redesigning of Production Process	Number of Design Changes	5,000	5	1,000 per design change	1,000	$ 4,000
Production Scheduling	Number of Batches	6,000	60	$ 100 per batch	4,000	2,000
Order Filling	Number of Sales Orders	200	7000	35 per sales order	3,150	3,850
Total Batch Level Costs					$ 8,150	9,850
Number of Packages					10,000	50,000
Cost per package					0.815	0.197
Unit Level Costs
Chilling	Weight in pounds	1,500	75,000	$ 0.02 per pound	0.05	0.02
Processing	Number of Cuts	19,200	160,000	0.12 per cut	0.12	0.36
Packaging	Cubic ft. of exposed surface	1,425	47,500	0.03	0.03	0.0225
Total indirect cost per package assigned					$ 1.02	$ 0.60

Statement showing assignment of indirect costs to products:

	Headless Shrimp	Peeled and Deveined Shrimp
Direct Material Cost	$ 3.60	$ 4.57
Direct Labor Cost	0.20	1.00
Indirect Cost	1.02	0.60
Total cost per package	$ 4.82	$ 6.17

3. The following table shows the total cost per package using oroginal costing method and activity costing method for both the products :

	Headless Shrimp	Peeled and Deveined Shrimp
Traditional Costing	$ 3.95	$ 6.34
Activity Based Costing	4.82	6.17

Using traditional costing, the company's cost at $ 3.95 for headless shrimps was far lower as compared to competitors, and as a result , it was winning the bids, but at the same time ending up making losses. On the other hand, it was losing the bids for peeled and deveined shrimps because its quotation based on traditional costing was probably higher than that of the other players in the market. So the company ended up losing market share in the second category.

Therefore, it is recommended that future bids are based on cost assigments using ABC method. In all probability, both bids can be won.