Reference no: EM13922361
World Gourmet Coffee Company (WGCC) is a distributor and processor of different blends of coffee. The company buys coffee beans from around the world and roasts, blends, and packages them for resale. WGCC currently has 15 different coffees that it offers to gourmet shops in one-pound bags. The major cost is raw materials; however, there is a substantial amount of manufacturing overhead in the predominantly automated roasting and packing process. The company uses relatively little direct labor.
Some of the coffees are very popular and sell in large volumes, while a few of the newer blends have very low volumes. WGCC prices its coffee at full product cost, including allocated overhead, plus a markup of 30 percent. If prices for certain coffees are significantly higher than market, adjustments are made. The company competes primarily on the quality of its products, but customers are priceconscious as well.
Data for the 20x1 budget include manufacturing overhead of $3,000,000, which has been allocated on the basis of each product's direct-labor cost. The budgeted direct-labor cost for 20x1 totals $600,000.
Based on the sales budget and raw-material budget, purchases and use of raw materials (mostly coffee beans) will total $6,000,000.
The expected prime costs for one-pound bags of two of the company's products are as follows:
Kona Malaysian
Direct material ...............$3.20 $4.20
Direct labor .....................30 .30
WGCC's controller believes the traditional product-costing system may be providing misleading cost information. She has developed an analysis of the 20x1 budgeted manufacturing-overhead costs shown in the following chart.
Activity Cost Driver Budgeted Activity Budgeted Cost
Purchasing ................................ Purchase orders ................................ 1,158 ..................$ 579,000
Material handling ....................... Setups ............................................ 1,800 ....................720,000
Quality control............................ Batches ........................................... 720 ..................... 144,000
Roasting .................................... Roasting hours .............................. 96,100 ...................... 961,000
Blending .................................... Blending hours.............................. 33,600 ...................... 336,000
Packaging ................................. Packaging hours ........................... 26,000 ...................... 260,000
Total manufacturing-overhead cost .................................................................................... $3,000,000
Data regarding the 20x1 production of Kona and Malaysian coffee are shown in the following table. There will be no raw-material inventory for either of these coffees at the beginning of the year.
Kona Malaysian
Budgeted sales ............................ 2,000 lb. 100,000 lb.
Batch size .....................................500 lb. 10,000 lb.
Setups .........................................3 per batch 3 per batch
Purchase order size .......................500 lb. 25,000 lb.
Roasting time ................................1 hr. per 100 lb. 1 hr. per 100 lb.
Blending time .................................5 hr. per 100 lb. .5 hr. per 100 lb.
Packaging time .............................. .1 hr. per 100 lb. .1 hr. per 100 lb.
Required:
1. Using WGCC's current product-costing system:
a. Determine the company's predetermined overhead rate using direct-labor cost as the single cost driver.
b. Determine the full product costs and selling prices of one pound of Kona coffee and one pound of Malaysian coffee.
2. Develop a new product cost, using an activity-based costing approach, for one pound of Kona coffee and one pound of Malaysian coffee.
3. What are the implications of the activity-based costing system with respect to
a. The use of direct labor as a basis for applying overhead to products?
b. The use of the existing product-costing system as the basis for pricing?
Bo Vonderweidt, the production manager for Sportway Corporation, had requested to have lunch with the company president. Vonderweidt wanted to put forward his suggestion to add a new product line. As they finished lunch, Meg Thomas, the company president, said, "I'll give your proposal some serious thought, Bo. I think you're right about the increasing demand for skateboards. What I'm not sure about is whether the skateboard line will be better for us than our tackle boxes. Those have been our bread and butter the past few years."
Vonderweidt responded with, "Let me get together with one of the controller's people. We'll run a few numbers on this skateboard idea that I think will demonstrate the line's potential."
Sportway is a wholesale distributor supplying a wide range of moderately priced sports equipment to large chain stores. About 60 percent of Sportway's products are purchased from other companies while the remainder of the products are manufactured by Sportway. The company has a Plastics Department that is currently manufacturing molded fishing tackle boxes. Sportway is able to manufacture and sell 8,000 tackle boxes annually, making full use of its direct-labor capacity at available work stations.
The selling price and costs associated with Sportway's tackle boxes are as follows:
Selling price per box ............................................................................................................... $86.00
Costs per box:
Molded plastic ........................................................................................................................ $ 8.00
Hinges, latches, handle ........................................................................................................... 9.00
Direct labor ($15.00 per hour) ............................................................................................... 18.75
Manufacturing overhead ........................................................................................................ 12.50
Selling and administrative cost .............................................................................................. 17.00 65.25
Profit per box ......................................................................................................................................... $20.75
Because Sportway's sales manager believes the firm could sell 12,000 tackle boxes if it had sufficient manufacturing capacity, the company has looked into the possibility of purchasing the tackle boxes for distribution. Maple Products, a steady supplier of quality products, would be able to provide up to 9,000 tackle boxes per year at a price of $68.00 per box delivered to Sportway's facility.
Bo Vonderweidt, Sportway's production manager, has come to the conclusion that the company could make better use of its Plastics Department by manufacturing skateboards. Vonderweidt has a market study that indicates an expanding market for skateboards and a need for additional suppliers.
Vonderweidt believes that Sportway could expect to sell 17,500 skateboards annually at a price of $45.00 per skateboard.
After his lunch with the company president, Vonderweidt worked out the following estimates with the assistant controller.
Selling price per skateboard ........................................................................................................ $45.00
Costs per skateboard:
Molded plastic ........................................................................................................................... $5.50
Wheels, hardware ...................................................................................................................... 7.00
Direct labor ($15.00 per hour) .................................................................................................... 7.50
Manufacturing overhead ............................................................................................................. 5.00
Selling and administrative cost .................................................................................................... 9.00 ......34.00
Profit per skateboard .................................................................................................................................... $11.00
In the Plastics Department, Sportway uses direct-labor hours as the application base for manufacturing overhead. Included in the manufacturing overhead for the current year is $50,000 of factorywide, fixed manufacturing overhead that has been allocated to the Plastics Department. For each unit of product that Sportway sells, regardless of whether the product has been purchased or is manufactured by Sportway, there is an allocated $6.00 fixed overhead cost per unit for distribution that is included in the selling and administrative cost for all products. Total selling and administrative costs for the purchased tackle boxes would be $10.00 per unit.
Required:
In order to maximize the company's profitability, prepare an analysis that will show which product or products Sportway Corporation should manufacture or purchase.
1. First determine which of Sportway's options makes the best use of its scarce resources. How many skateboards and tackle boxes should be manufactured? How many tackle boxes should be purchased?
2. Calculate the improvement in Sportway's total contribution margin if it adopts the optimal strategy rather than continuing with the status quo.