ABC, activity area cost-driver rates, product ...

[KimWrice]

ABC, activity area cost-driver rates, product cross-subsidization.
 
  Intex Potatoes (IP) operates at capacity and processes potatoes into potato cuts at its highly automated Pocatello plant. It sells potatoes to the retail consumer market and to the institutional market, which includes hospitals, cafeterias, and university dormitories.
   IP's simple costing system, which does not distinguish between potato cuts processed for retail and institutional markets, has a single direct-cost category (direct materials; that is, 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 cuts processed. The company uses 1,800,000 pounds of raw potatoes to process 1,600,000 pounds of potato cuts. At the end of 2014, IP 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 IP included only a minimum profit margin on its bid, and the Pocatello plant was acknowledged as the most efficient in the industry.
   As a result of its review process of the lost contract bid, IP 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 (190,000 for retail and 9,000 for institutional). Also, the company used ABC to identify three main activity areas that generated support costs: cleaning, cutting, and packaging.
 
   Cleaning Activity AreaThe cost-allocation base is pounds of raw potatoes cleaned.
   Cutting Activity AreaThe production line produces (a) 150 pounds of retail potato cuts per cutting-hour and (b) 200 pounds of institutional potato cuts per cutting-hour. The cost-allocation base is cutting-hours on the production line.
   Packaging Activity AreaThe packaging line packages (a) 25 pounds of retail potato cuts per pack- aging-hour and (b) 80 pounds of institutional potato cuts per packaging-hour. The cost-allocation base is packaging-hours on the production line.
 
  The following table summarizes the actual costs for 2014 before and after the preceding cost analysis.
 
  Required:
  1. Using the simple costing system, what is the cost per pound of potato cuts produced by IP?
  2. Calculate the cost rate per unit of the cost driver in the (a) cleaning, (b) cutting, and (c) packaging activity areas.
  3. Suppose IP uses information from its activity cost rates to calculate costs incurred on retail potato cuts and institutional potato cuts. Using the ABC system, what is the cost per pound of (a) retail potato cuts and (b) institutional potato cuts?
  4. Comment on the cost differences between the two costing systems in requirements 1 and 3. How might IP use the information in requirement 3 to make better decisions?

Question 2

Content analysis is a quantitative method of determining characteristics of interest.
 
  Indicate whether the statement is true or false

[Ahernandez18]

Answer to Question 1

1. Direct costs
Direct materials  231,000
Indirect costs
Product support 1,689,000
Total costs 1,920,000

Cost per pound of potato cuts = = 1.20

2. Cost Costs in Number of Costs per
Pool Pool Driver Units Driver Unit
Cleaning 270,000 1,800,000 raw pounds  0.15
Cutting 624,000 10,400 hours 60.00
Packaging 596,000 59,600 hours 10.00

((1,600,000  90)  150) + ((1,600,000  10)  200) = 9,600 + 800 = 10,400 hours
(1,440,000  25) + (160,000  80) = 57,600 + 2,000 = 59,600 hours

3. Retail Potato Cuts Institutional Potato Cuts
Direct costs
Direct materials 207,900 23,100
Packaging 190,000  397,900 9,000  32,100
Indirect costs
Cleaning
0.15  90  1,800,000 243,000
0.15  10  1,800,000 27,000
Cutting
60  9,600 hours 576,000
60  800 hours 48,000
Packaging
10  57,600; 10  2,000 576,000 1,395,000 20,000 95,000
Total costs 1,792,900 127,100
Pounds produced 1,440,000 160,000
Costs per pound  1.245  0.794

Note: The total costs of 1,920,000 (1,792,900 + 127,100) are the same as those in Requirement 1.

4. There is much evidence of product-cost cross-subsidization.

Cost per Pound Retail Institutional
Simple costing system 1.20 1.20
ABC system 1.245 0.794

Assuming the ABC numbers are more accurate, potato cuts sold to the retail market are undercosted, while potato cuts sold to the institutional market are overcosted.
The simple costing system assumes each product uses all the activity areas in a homogeneous way. This is not the case. Institutional sales use sizably less resources in the cutting area and the packaging area. The percentages of total costs for each cost category are as follows:
Retail Institutional Total
Direct costs
Direct materials 90.0 10.0 100.0
Packaging 95.5 4.5 100.0
Indirect costs
Cleaning 90.0 10.0 100.0
Cutting 92.3 7.7 100.0
Packaging 96.6 3.4 100.0
Units produced 90.0 10.0 100.0

Intex can use the revised cost information for a variety of purposes:
a. Pricing/product emphasis decisions. The sizable drop in the reported cost of potatoes sold in the institutional market makes it possible that Intex was overpricing potato products in this market. It lost the bid for a large institutional contract with a bid 30 above the winning bid. With its revised product cost dropping from 1.20 to 0.794, Intex could have bid much lower and still made a profit. An increased emphasis on the institutional market appears warranted.
b. Product design decisions. ABC provides a road map as to how to reduce the costs of individual products. The relative components of costs are:

Retail Institutional
Direct costs
Direct materials 11.6 18.2
Packaging 10.6 7.1
Indirect costs
Cleaning 13.6 21.2
Cutting 32.1 37.8
Packaging 32.1 15.7
Total costs 100.0 100.0

Packaging-related costs constitute 42.7 (10.6 + 32.1) of total costs of the retail product line. Design efforts that reduce packaging costs can have a big impact on reducing total unit costs for retail.
c. Process improvements. Each activity area is now highlighted as a separate cost. The three indirect cost areas comprise over 70 of total costs for each product, indicating the upside from improvements in the efficiency of processes in these activity areas.

Answer to Question 2

FALSE
Explanation: Content analysis is a qualitative method of determining characteristics of interest based on grammatical structure, word content, and other fundamental characteristics of communication.

[KimWrice]

Thank you

[Ahernandez18]

No problemo