California Creamery, Inc

Mid Term Assignment Irma Irsyad1040002194

MM Executive – Batch 11

About California Creamery Inc. 14 retail ice cream stores: spread throughout

Southern California, from San Luis Obispo to San Diego

Sold only the highest quality, ultra premium ice cream and offers 25 different ice cream flavors

Many of the flavors were “exotic": “Polynesian Fantasy,” “Mango-Lemon Supreme,” and “Multi-Nut Twist.”

A few of the exotic flavors sold in low volumes Sold a few traditional ice cream flavors: vanilla,

chocolate, strawberry, and coffee Earlier ice cream was produced in the garage of

the company’s founder, Will Forgey Uses automated manufacturing equipment that

blended the flavors and packaged the liquid ice cream in preparation for freezing

The most significant production costs: raw materials, particularly cream, sugar, and the special flavor ingredients, and for the acquisition, operation and maintenance of the production equipment

All products were sold at the same retail price Prices are set to yield, roughly, a markup of 100%

on average full production costs Manufacturing overhead of $600,000 (2010

budget) A proportion of the direct labor used in the

production process Total direct labor costs for 2010 was $300,000 Charged the overhead to products at a rate of 200

% of direct labor costs All products were sold at the same retail price

Will’s pricing policy was not accurate as all products were sold at the same retail price

Problems and Issues

Exhibit 1: Overhead Cost Activity

Activity Budgeted Costs (000) Driver of the Activity CostsBudgeted Activity Level for the Cost

DriverPurchasing 80$ Purchase orders $ 909 Material handling 95$ Setups $ 1,846 Blending 122$ Blender hours $ 1,000 Freezing 175$ Freezer hours $ 1,936 Packaging 110$ Packaging machine hours $ 1,100 Quality Control 18$ Batches $ 286 Total Manufacturing Overhead costs

600$

California Creamery, INC.

2010 Budgeted Manufacturing Overhead Costs

Exhibit 2:

Polynesian Fantasy VanillaDirect material $2.00 $1.80

Direct labor 1.2 1.2Budgeted productn & sales 2,000 100,000

Batch size 100 2,500

Setups 3 3

Purchase order size 50 1,000

Blender time 0.6 0.3

Freezer time 1 1

Packaging machine time 0.3 0.2

California Creamery, INC.Two Product Examples (2010 data)

Polynesian Fantasy Vanilla Polynesian Fantasy Vanilla

$2,400.00 $120,000.00 $ 4,000 180,000$

OverheadDirect Labour Direct Material

Issues and Problems Prepare a Case analysis and answer the following questions:

1.Compute the full production cost (per gallon) of the Polynesian Fantasy and Vanilla products using:

a. Will’s old costing method

b. The new costing method (Louise’s suggestion)

a. Will’s old costing method

2,400$

120,000$

4,000$

Direct material for Vanilla = $1.80 per gallon x 100,000 gallons 180,000$

Overhead is 2 times of the direct labour (given in the Case)

Polynesian Fantasy = 2 x $2,400 4,800$

Vanilla = 2 x $120,000 240,000$

Direct material for Polynesian Fantasy = $2 per gallon x 2,000 gallons

Direct Labour for Polynesian Fantasy = $1.20 per gallon x 2,000 gallons

Direct Labour for Vanilla = $1.20 per gallon x 100,000 gallons

Referring to the earlier calculation:

Polynesian Fantasy VanillaUnits Produced 2,000$ 100,000$ Direct Labor Cost ($) 2,400$ 120,000$ Direct Material Cost ($) 4,000$ 180,000$ Overhead Cost ($) 4,800$ 240,000$ Total Cost ($) 11,200$ 540,000$ Cost per unit 5.60$ 5.40$

California Creamery, INC.Two Product Examples (2010 data)

5.60$ 5.40$

Full Production cost for Polynesian Fantasy (per gallon)Full Production cost for Vanilla (per gallon)

b.The new costing method (Louise’s suggestion)

Activity Budgeted Costs (000) Driver of the Activity CostsBudgeted Activity Level for the Cost

DriverCost / Unit

Purchasing $ 80,000 Purchase orders $ 909 88.01$ Material handling $ 95,000 Setups $ 1,846 51.46$ Blending $ 122,000 Blender hours $ 1,000 122.00$ Freezing $ 175,000 Freezer hours $ 1,936 90.39$ Packaging $ 110,000 Packaging machine hours $ 1,100 100.00$ Quality Control $ 18,000 Batches $ 286 62.94$ Total Manufacturing Overhead costs

$ 600,000

California Creamery, INC.2010 Budgeted Manufacturing Overhead Costs

Referring to Exhibit 1:

20

40

60

120

40

100

12

300

20

1000

6

200

Total Packaging time (Hrs) for Polynesian Fantasy = 2,000 x 0.3 : 100

Total Packaging time (Hrs) for Vanilla = 100,000 x 0.2 / 100

Total Purchase orders/Purchasing for Vanilla (gallons) = 100,000 gallons : 1,000 gallons

Total Blending time (Hrs) for Polynesian Fantasy = 2,000 gallons x 0.6 hrs : 100 gallons

Total Blending time (Hrs) for Vanilla = 100,000 gallons x 0.3hrs :100 gallons

Total freezing time (Hrs) for Polynesian Fantasy = 2,000 gallons x 1 hr : 100 gallons

Total freezing time (Hrs) for Vanilla = 100,000 gallons x 1 hr : 100 gallons

Total Batch size/Quality Control for Polynesian Fantasy (gallons) = 2,000 gallon : 100 gallons

Total Batch size/Quality Control (gallons) for Vanilla

Total Set up/Material Handling(per batch) for Polynesian Fantasy = 20 gallons x 3

Total Set up/Material Handling (per batch) for Vanilla = 40 gallons x 3

Total Purchase orders/Purchasing for Polynesian Fantasy (gallons) = 2,000 gallons : 40 gallons

Direct Cost details:

Polynesian Fantasy Vanilla

Total Direct Labour 2,400$ 120,000$ [$1.2 x Budgeted Prod & Sales]

Total Direct Material 4,000$ 180,000$ [$2 x Budgeted Prod & Sales]

6,400$ 300,000$

Based on the above information and per unit cost calculated from Exhibit 1:

Purchase Overhead 3,520.35$ 8,800.88$ Mat.Handling Setup 3,087.76$ 6,175.51$ Blending Overhead 1,464.00$ 36,600.00$ Freezing overhead 1,807.85$ 90,392.56$ Packaging Overhead 600.00$ 20,000.00$ Quality Overhead 1,258.74$ 2,517.48$ Total 11,738.70$ 164,486.44$

Overhead Details Polynesian Fantasy Vanilla

Total cost for Polynesian Fantasy = $11,738.70 + $6400 18,138.70$

Total cost for Vanilla = $164,486.44 + $300,000 464,486.44$

Unit cost for Polynesian Fantasy = $ 18,138.70 / 2,000 9.07$

Unit cost for Vanilla = $ 464,486.44/ 100,000 4.64$

Unit cost for Polynesian Fantasy 9.07$

Unit cost for Vanilla 4.64$

2.What are the effects, if any, of changing the company’s costing method? Specifically, are the differences between the two costing methods material in terms of:

a. Their effect on individual product costs?

The change in company's costing method will be most likely impact the costs of each individual product. How the California Creamery allocate its overhead costs across its product portfolio will have an impact on the company's product Mix and pricing strategy The current costing method that Will is currently using is simple but not accurate as it pictures the wrong description on the profitability of a product, as the overhead cost's allocation is based on consumption Direct Labour hours for a product, whereas base on the reality overhead cost is created based on individual activities which may or may not directly proportionate to the Direct Labour costs

The ABC method gives both accurate description of the costs and product's profitability Instead of placing the Direct Labour as the product base, the ABC method divides the Overhead costs into various activities based on activity's consumption in producing the product (e.g. Quality Overhead costs are allocated based in 'Number of batches' of the product base.

As shown on the table of comparison of Overhead costs alocation for Polynesian and Vanilla below, it changed the total cost per unit.

Polynesian Fantasy Vanilla Traditional costing method 4,800.00$ 240,000.00$ ABC method 11,738.70$ 164,486.44$ Percentage change 144.56 -31.46

It is clear that the ABC method is accurate as it allocates overhead cost appropriately based on the activity's consumption

The Polynesian Fantasy is heavily underpriced where Vanilla being overpriced as shown on the table below:

ABC Method 9.07$ 4.64$ Traditional Method 5.60$ 5.40$ Underpriced/ Overpriced -61.96 14.07

Method Polynesian Fantasy Vanilla

b. Their effect on total company profits? (Assume no changes in any operating decisions, such as prices and production volumes.)

There will be no any effect in the total of the company profit by the change in company's costing method as the whole as costing is an internal process of profitability of a number of product will be compensated by a decrease in others.

3. What should Will do now? Explain.

Will should implement the ABC method even though this does not increase the overall profit of the company. The ABC method will be able to help him to closely analysing the costs associated with each individual product to improve the manufacturing process and efficiency which will then increase the company's profitability

The ABC method gives Will the exact cost of each of individual product which can be used to project future strategy for Marketing product mix, marketing effort and profitability. Will have the details of Overhead costs as well as the cost driver, the company have multiple products which consume the same overhead, produces in batches; which fulfilled the requirement of using ABC method.

The monitoring of implemented ABC method will required in order to examine the profitability of each product

Conclusion and Recommendation

Will should implement the ABC method even though this does not increase the overall profit of the company. The ABC method will be able to help him to closely analysing the costs associated with each individual product to improve the manufacturing process and efficiency which will then increase the company's profitability

Thank you