Question

Case: Cost System Considerations for CANADA SNOWCONES LTD.

Canada Snowcones Ltd. (CSL) owned and operated 20 retail frozen yogurt stores spread throughout Southern Ontario, from Toronto to Windsor. CSL's stores sold only high quality, premium frozen yogurt. They offered an assortment of 35 different frozen yogurt flavours. A significant amount of the CSL flavours were special, such as "Peanut Butter Bacon", "Charcoal-Sushi", and "Tropical Cheese Sensations". However, CSL also sold a few of the classic frozen yogurt flavours, such as vanilla, milk chocolate, mint, and other singular fruit flavours. While some of the flavours were very popular, there were also some of the more peculiar flavours that had low total sales in terms of units.

CSL produced its own frozen yogurt. The founder of the company, Samantha Reynolds, had originally made the yogurt in her basement. But eventual growing demand led to Samantha renting part of factory for CSL's production. As CSL grew, Samantha was able to afford automated but more costly production equipment that blended the flavours and packaged the liquid frozen yogurt for freezing. CSL's most significant production costs were for raw materials, particularly yogurt, brown sugar, and the special flavour ingredients, and for the purchase, operation, and maintenance of production equipment.

All of CSL's products had the same retail price, as customers could choose or combine any flavours by scoops. Samantha set the prices to generate, on average, a markup of 100% on average full production costs. CSL's 2019 budget included manufacturing overhead (MOH) of $450,000. To estimate product costs, Samantha spread this MOH cost to products based on a proportion of the direct labour (DL) costs used in the production process. CSL's total DL costs for 2019 was $200,000, so Samantha charged the overhead to products at a rate of MOH to total DL costs.

Last week, Laura Horton, Samantha's babysitter for her daughter and the CEO of a large production firm, advised that Samantha's pricing strategy was not optimal. Laura's insight was that the expenses for producing CSL's numerous flavours were not uniform. She thought those inconsistencies should be reflected in the prices charged, or CSL's earnings would fluctuate as the combination of flavours sold varied.

Laura proposed that Samantha reestimate product costs using activity-based costing. She recommended that Samantha identify the major activities whose costs were included in the company's MOH costs. Then, she should apply these costs to products based on the products consumption of each of those activities. In response to Laura's suggestions, Samantha prepared the information presented below in Table 1.

Samantha decided to hire your consulting firm to help calculate the costs of two demonstrative flavours as an experiment to see if Laura's activity based costing system suggested produced any significant contrasts. She asked Laura to take her best estimate as to where she might find the most material differences, if any existed. After Samantha described the products to her, Laura suggested that she use Peanut Butter Bacon and Chocolate as the test product examples. Table 2 provides data relevant to the two selected products.

Tables 1 and 2

Case Questions

1. Utilizing the information above, calculate the full product cost (on a per gallon basis) of the Peanut Butter Bacon and Chocolate flavours utilizing:

a. Samantha's more traditional costing system.

b. Laura's suggestion to use activity-based costing.

2. What are the impacts, if there is any at all, of switching CSL's costing method? In particular, are the any significant contrasts between traditional costing and activity-based costing in terms of:

a. Their impact on costs for independent products.

b. Their effect on CSL's total firm income? (assuming everything else remains the same, such as production and sales prices)

c. If there are significant contrasts, why are they present? If there are no significant contrasts, why are they not present?

3. What would you recommend to be Samantha's next step, based on this analysis? Explain.

Answer 1

1A)

calculation showing the full product cost (on a per-gallon basis) of the Peanut Butter Bacon and Chocolate flavors utilizing Samantha's more traditional costing system:

Overhead absorption rate calculation:

Overhead Absorption rate = Total Manufacturing Overhead/Direct Labor Cost= $45,000/$20,000*100=225%

which means the overhead cost is 2.25 times the labor cost.

	Particulars	Peanut Butter	Chocolate
A	Production and sales (in gallons)	1,500	80,000
B	Direct Material	$2.2*1,500=$3,300	$1.9*80,000=$152,000
C	Direct labor	$1.4*1,500=$2,100	$1.4*80,000=$112,000
D=C*2.25	Absorbed Manufacturing Overheads	$2,100*2.25=$4,725	$112,000*2.25=$252,000
E=B+C+D	Total Product cost (2 to 4)	$10,125	$516,000
F=E/A	Total Cost per gallon	$6.75	$6.45

1B) calculation showing the full product cost (on a per-gallon basis) of the Peanut Butter Bacon and Chocolate flavors utilizing Laura's suggestion to use activity-based costing:

	Activity	Cost Driver	Total Cost(in $)	Cost per Cost Driver
			(1)	(1/cost driver)
A	Purchase	Purchase orders	60,000	60,000/829=72.38 per purchase order
B	Material handling	Number of setups	71,250	71,250/1,766=40.34 per setup
C	Mixing	Mixing hours	91,500	91,500/920=99.46 per mixing hour
D	Chilling	Chilling hours	131,250	131,250/1,856=70.72 per chilling hour
E	Packaging	Packaging Machine hours	82,500	82,500/1,020=80.88 per machine hour
F	Quality Control	Number of batches	13,500	13,500/206=65.53 per batch
G=A+B+C+D+E+F	Total (1 to 6)		450,000

Product cost computation:

Particulars	Peanut Butter	Chocolate
1. Units Produced and Sold (in gallons)	1,500	80,000
2.Direct Materials(from (A))	3,300	152,000
3.Direct Labor(from (A))	2,100	112,000
4.Manufacturing Overheads
Purchasing	$72.38*[1,500/40]=2,714.25	$72.38*[80,000/500]=11,580.8
Material handling	$40.34*[1,500/100]*3=1,815.3	$40.34*[80,000/4,000]*3=2,420.4
Mixing	$99.46*[1,500/100]*0.4=596.76	$99.46*[80,000/100]*0.2=15,913.6
Chilling	$70.72*[1,500/100]*1.5=1,591.2	$70.72*[80,000/100]*1.5=84,864
Packaging	$80.88*[1,500/100]*0.5=606.6	$80.88*[80,000/100]*0.25=16,176
Quality Control	$65.53*[1,500/100]=982.95	$65.53*[80,000/4,000]=1,310.6
Total	8,307.06	132,265.40
5.Total Product Cost(2 to 4)(rounded off)	13,707	396,265
6.Total Product Cost per gallon	$9.14	$4.95

2A)

There is an impact on product cost:

Particulars	Traditional costing system	Activity-Based Costing system	Difference
Peanut Butter	$6.75	$9.14	increased by $2.39
Chocolate	$6.45	$4.95	decreased by $1.50

2B)

There will not be any impact of choosing given any of the costing methods on total firm income since cost gets allocated among various products and the overall cost will not change.

The only effect will be there on product level cost and profitability analysis.

2C)

There are considerable differences between the traditional and ABC system of cost. The traditional system is volume-based, which is not a great parameter when the entity has more than one product and is different.

In the given case, the company has to use the ABC costing system since it provides proper results with regard to an organization that has multiple heterogeneous products, and also the production is machine-based.

As the cost ascertainment is based on various activities involved in producing the product and not based on a single overhead absorption rate, the true effects are made to the product cost.

3)Recommendation:

Peanut butter Bacon is having higher activity consumption for production. So, the firm should review the activities consumed and try to reduce the same so that cost allocation to it reduces and cost per unit decreases.

Allocation of overhead asper direct labor cost method does not correlate the cost with activities consumed. Therefore, the ABC system of costing should be used since it has the following additional advantages:

1. It helps is accurate product costing,

2. It helps in better cost management through cost control and cost reduction.