In: Accounting
Crunch is King, Inc. operates at capacity and processes potatoes into potato chips in a highly automated manufacturing facility. The company sells chips to the retail consumer market and to the institutional market, which includes hospitals, cafeterias, and universities.
Crunch’s simple costing system, which does not distinguish between potato chips processed for retail and institutional markets, has a single direct-cost category (direct materials, i.e. raw potatoes) and a single indirect-cost pool (production support). Support costs, which include packaging materials, are allocated on the basis of pounds of potato chips processed. The company uses 1,200,000 pounds of raw potatoes to process 1,000,000 pounds of potato chips. At the end of 2018, Crunch unsuccessfully bid for a large institutional contract. Its bid was reported to be 30% above the winning bid. This feedback came as a shock because the company included only a minimum profit margin on its bid and the plant was acknowledged as the most efficient in the industry.
As a result of its review process of the lost contract bid, Crunch has decided to explore ways to refine its costing system. The company determined that 90% of the direct materials (raw potatoes) related to the retail market and 10% to the institutional market. In addition, the company identified that packaging materials could be directly traced to individual jobs ($180,000 for retail and $8,000 for institutional). Also, the company used ABC to identify three main activity areas that generated support costs: cleaning, cutting and packaging. The following information relates to the three areas identified:
Activity Area |
Cost Allocation Base |
Production |
Cleaning |
pounds of raw potatoes |
n/a |
Cutting |
cutting hours |
Retail 250 pounds/cutting hour Institutional 400 pounds/cutting hour |
Packaging |
packaging hours |
Retail 25 pounds/packaging hour Institutional 100 pounds/packaging hour |
Crunch (cont.)
The following table summarizes the actual cost for 2018 before and after the preceding cost analysis:
before |
after |
||||
Production Support |
Retail |
Institutional |
Total |
||
Direct materials used |
|||||
Potatoes |
$150,000 |
$135,000 |
$15,000 |
$150,000 |
|
Packaging |
180,000 |
8,000 |
188,000 |
||
Production Support |
983,000 |
||||
Cleaning |
$120,000 |
120,000 |
|||
Cutting |
231,000 |
231,000 |
|||
Packaging |
444,000 |
444,000 |
|||
Total |
$1,133,000 |
$795,000 |
$315,000 |
$23,000 |
$1,133,000 |