Question

Rick White has recently discussed the intent to diversify Swiss Chocolate’s product line with Steve Smith. Smith notes that the new product will be a dark chocolate candy bar featuring various types of dried fruit and a higher percentage of cacao, which will be touted as a heart-healthy product due to high antioxidant nutritional qualities. This differs from the current basic milk-chocolate bar that Swiss Chocolate manufactures presently, which has no added fruit. White has related the fact that the company expects this coming year’s milk-chocolate bar volume to decline and the new product volume to rise. There will be a new machine required to accommodate the new product, and it will run in batches.

White suggests that Smith consider activity-based costing for completing this analysis. Before Smith undertakes this analysis, he considers the advantages and disadvantages of implementing activity-based costing.

Select a position on implementing ABC for this scenario and defend it to your classmates. Include reasons and support for your position.

Answer 1

Activity based costing analysis will be beneficial in the given context and therefore, should be implemented.

Reason in favour are as follows:

In general, activity based costing (ABC) method provides a more detailed cost analysis for costs attributable to products. Rather than allocation of overhead costs based on a pre determined hourly rate (labour or machine hours). This is because ABC is a lot more detailed in identifying costs attributable to the products and therefore, faciliates better decisions.

For eg. in the above case, if overhead costs are to be allocated to both the products, an hourly rate may not always be reflective of the work done by these departments towards respective products. This is because the time taken for procurement of regular cocoa, special cocoa, dry fruits etc may be different and may involve a lot of different activities. This can also be driven by the number of shipments received, number of quality checks to be performed, any special despatch or packing required for chocolates with dried fruit, etc. Therefore, a flat rate of overhead across different functions like procurement, quality control, despatch, material inward, storage space etc may not be reflective of the cost/resources consumed by the respective products. Therefore, it is essential to understand what activities are performed for which products and allocate costs accordingly.

Potential disadvantages:

It requries significant implementation effort. Further, in case of any sibsequent restructuring activity within departments, the activities identified may need to be revisited. However, most of these activities are one time efforts and worth the investment, as wrong cost allocation can often distort the profitability picture of various products and lead to wrong management decisions.