Coffee Bean Inc.
Coffee Bean, Inc. (CBI), is a processor and distributor of a variety of blends of coffee. The company buys coffee beans from around the world and roasts, blends, and packages them for resale. CBI currently has 40 different coffees that it sells to gourmet shops in one-pound bags. The major cost of the coffee is raw materials. However, the company’s predominately automated roasting, blending, and packing process requires a substantial amount of manufacturing overhead.
The company uses relatively little direct labor. Some of CBI’s coffees are very popular and sell in large volumes, while a few of the newer blends have very low volumes. CBI prices its coffee at manufacturing cost plus a markup of 30%. If CBI’s prices for certain coffees are significantly higher than market, adjustments are made to bring CBI’s prices more into alignment with the market since customers are somewhat price conscious.
For the coming year, CBI’s budget includes estimated manufacturing overhead cost of $3,000,000. CBI assigns manufacturing overhead to products on the basis of direct labor-hours. The expected direct labor cost totals $600,000, which represents 50,000 hours of direct labor time. Based on the sales budget and expected raw materials costs, the company will purchase and use $6,000,000 of raw materials (mostly coffee beans) during the year.
The expected costs for direct materials and direct labor for one-pound bags of two of the company’s coffee products appear below: | | | | |Mona Loa | |Malaysian | | | |Direct materials | |$ 4. 0 | |$ 3. 20 | | | |Direct labor | |0. 30 | |0. 30 | | | CBI’s controller believes that the company’s traditional costing system may be providing misleding cost information.
To determine whether or not this is correct, the controller has prepared an analysis of the year’s expected manufacturing overhead costs, as shown in the following table: |Activity Cost Pool | |Activity Measure | |Expected Activity for the Year | |Expected Cost for the Year | | | |Purchasing | |Purchase orders | |1,710 orders | |$513,000 | | | |Materials handling | |# of Setups | |1,800 setups | |720,000 | | | |Quality control | |# of Batches | |600 batches | |144,000 | | | |Roasting | |Roasting-hours | |96,100 roasting hours |961,000 | | | |Blending | |Blending-hours | |33,600 blending hours | |402,000 | | | |Packaging | |Packaging-hours | |26,000 packaging hours | |260,000 | | | |Total manufacturing overhead cost | |$3,000,000 | | | Data regarding the expected production of Mona Loa and Malaysian coffee are presented below. | | | | | |Mona Loa | | | |Malaysian | | | |Expected sales | | | |100,000 pounds | | | |2,000 pounds | | |Batch size | | | |10,000 pounds | | | |500 pounds | | | |Setups | |3 per batch | |3 per batch | | | |Purchase order size | | | |20,000 pounds | | | |500 pounds | | | |Roasting time per 100 pounds | | | |1 hour | | | |1 hour | | | |Blending time per 100 pounds | | | |0. 5 hour | | | |0. hour | | | |Packaging time per 100 pounds | | | |0. 1 hour | | | |0. 1 hour | | | 1.
Using the direct labor-hours as the base for assigning manufacturing overhead cost to products, do the following: a. Determine the predetermined overhead rate that will be used during the year. b. Determine the unit product cost of one pound of the Mona Loa coffee and one pound of the Malaysian coffee. 2. Using activity-based costing as the basis for assigning manufacturing overhead cost to products, do the following: a. Determine the total amount of manufacturing overhead cost assigned to the Mona Loa coffee and to the Malaysian coffee for the year. b. Using the data developed in 2(a), computer the amount of manufacturing overhead cost per pound of the Mona Loa coffee and the Malaysian coffee.
Round all computations to the nearest whole cent. c. Determine the unit product cost of one pound of the Mona Loa coffee and one pound of the Malaysian coffee. Write a brief memo to the president of CBI explaining what you have found in (1) and (2) above and discussing the implications to the company of using direct labor as the base for assigning manufacturing overhead cost to products. MEMORANDUM To:The president of CBI From: Date: Subject:the implications to the company of using direct labor as the base for assigning manufacturing overhead cost to products. 1) Per pound cost of the Mona Loa coffee and the Malaysian coffee as per traditional costing system is $ 6 and $ 5 respectively. ) The manufacturing overhead assigned to each pound of the Mona Loa coffee and the Malaysian coffee is same because the direct labour hours required for manufacturing each pound of coffee are same 3) Per pound cost of the Mona Loa coffee and the Malaysian coffee as per Activity based costing system is $ 4. 83 and $ 7. 15 respectively. 4) Following are the implications to the company of using direct labor as the base for assigning manufacturing overhead cost to products: 1. Price determination under existing costing system (using direct labor as the base) is not accurate. Under activity based costing cost is calculated more accurately than existing product costing system. 2. Higher prices of popular product affect market adversely.
As the customers are price conscious company can sell Mona Loa Coffee (which is more popular) at lower price and can increase its market share if the cost is calculated accurately. 3. As company uses relatively little direct labour, direct labour is not an appropriate basis for applying overheads to products. 4. By using activity based costing company can discontinue its non-profitable products or suggest appropriate price for those product 5) Activity based costing allocated indirect cost more accurately . It helps in reducing the cost by eliminating unwanted activities Helps in improving product and customer profitability. Activity based costing helps in forecasting and planning.