Reference no: EM132368756

Case 18-2 - California Creamery, Inc.*

California Creamery, Inc. (CCI) owned and operated 14 retail ice cream stores spread throughout Southern California, from San Luis Obispo to San Diego. CCI's stores sold only the highest-quality, ultra-premium ice cream. They offered 25 different ice cream flavors. Many of the CCI flavors were "exotic," such as "Poly-nesian Fantasy," "Mango-Lemon Supreme," and "Multi-Nut Twist." But CCI also sold a few traditional ice cream flavors, such as vanilla, chocolate, straw-berry, and coffee. Some of the flavors were very popu-lar, but a few of the exotic flavors sold in low volumes.

CCI produced its own ice cream. Originally the ice cream was produced in the garage of the company's founder, Will Forgey. But the company outgrew the garage, and Will had since leased a building to house CCI's production activities. As CCI had grown, Will had been able to afford more expensive, automated manufacturing equipment that blended the flavors and packaged the liquid ice cream in preparation for freezing. CCI's most significant production costs were for raw materials, particularly cream, sugar, and the special flavor ingredients, and for the acquisition, operation, and maintenance of the production equipment. All of CCI's products were sold at the same retail price. Will set the prices to yield, roughly, a markup of 100 percent on average full production costs. CCI's 2004 budget included manufacturing overhead of $600,000. To estimate product costs, Will spread this overhead cost to products based on a proportion of the direct labor used in the production process. CCI's total direct labor cost for 2004 was $300,000, so Will charged the overhead to products at a rate of 200 percent of direct labor costs.

One day in a casual conversation, Louise Fettinger, Will's neighbor and a controller of a small manufac¬turing company, suggested that Will's pricing policy was not very smart. Louise's intuition was that the costs of producing CCI's various flavors were very, dif¬ferent. She thought those differences should be re¬flected in the prices charged, or CCI's profits would vary as the mix of products sold varied.

Louise suggested that Will reestimate product costs using what she called an "activity-based" cost the company's overhead costs. Then he should apt?' those costs to products based on the products' et; sumption of each of those activities. In response to Louise's suggestion, Will prepared the information shown in Exhibit 1.

Then, again following Louise's suggestion, he de-cided to calculate the costs of two illustrative products as an experiment to see ffLomse's new cost system idea produced any material differences. He asked Louise to take her best guess as to where he might find i the most significant differences, if any existed. After Will described the products to her, Louise suggested that he use Polynesian Fantasy and Vanilla as the test product examples. Exhibit 2 provides data pertinent to those two products.

EXHIBIT 1

CALIFORNIA CREAMERY, INC.
2004 Budgeted Manufacturing Overhead Costs

Activity	Budgeted Cost ($000)	"Driver" of the Activity's Costs	Budgeted Activity Level for the Cost Driver
Purchasing	$ 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

EXHIBIT 2

CALIFORNIA CREAMERY, INC.
Two Product Examples (2004 Data)

	Polynesian Fantasy	Vanilla
Direct material	$2.00/gallon	$1 .80/gallon
Direct labor	1.20/gallon	1.20/gallon
Budgeted production and sales	2,000 gallons	100,000 gallons
Batch size	100 gallons	2,500 gallons
Setups	3 per batch	3 per batch
Purchase order size	50 gallons	1,000 gallons
Blender time	0.6 hour per 100 gallons	0.3 hour per 100 gallons
Freezer time	1.0 hour per 100 gallons	1.0 hour per 100 gallons
Packaging machine time	0.3 hour per 100 gallons	0.2 hour per 100 gallons

Problem 17-2.

Burtis Company produce whose sales are    s a number of products. In 20x2 the selling price of product A, normally 10,000 units per year, was calculated as follows:

	Unit Costs
Direct material cost	$ 4.00
Direct labor cost	7.00
Overhead cost	4.80
Selling and administrative cost	3.50
Full cost	19.30
Profit (10% of full cost)	1.93
Selling price	$21.23

In 20x3 the company estimates that direct material cost and direct labor cost will increase by 12 percent. It also estimates that overhead cost will increase by a total of $6,000 and that selling and administrative cost and sales volume will remain unchanged.

Required:

What is the normal selling price fro product A in 20X3?

Problem 17-4

Valade Company produces two products, J and K. Estimated costs are presented below for a year in which 10,000 units of each product are expected to be sold:

	Total	Product J	Product K
Direct production cost	$700,000	$400,000	$300,000
Overhead cost	280,000	160,000	120,000
Selling and administrative cost	140,000	80,000	60,000

An annual profit of $280,000 for the whole company is considered satisfactorylt company uses the same profit margin (as a percentage of costs) to arrive at the price for both products.

Required:

a. Calculate normal selling prices for products J and K.

b. Using the prices calculated above, how much profit would result if the sales we 5,000 units of J and 15,000 units of K instead of 10,000 units of each?

c. Comment on the effect of changes in the product mix on total profit when the same profit margin percentage is used.

Problem 18-1.

Elliott Company estimated that costs of production for the coming year Would be

Raw materials    $ 75,000

Direct labor    90,000

Production overhead    135,000

Required:

a. Calculate the overhead rate for the next year, assuming that it is based on direct labor dollars.

b. Journalize the entry necessary to show the total cost of production for the mouth of May if the raw materials put into production totaled $6,000 and direct labor
$6,600.    Is

c. If actual production overhead costs incurred in May were $9,550, calculate the overabsorbed overhead for the month.

Problem 18-2.

The adjusted trial balance of Ryan Corporation includes the following overhead costs that are to be distributed before the books are closed to its three cost centers: A, B, and C.

	Total	Building	Furniture and Fixtures	Machinery and Equipment
Heat, light, power	$40,000
Depreciation	23,800	$3,000	$800	$20,000
Insurance:      Inventories      Other	200 2,210	1,300	60	850
Repairs	5,900	4,000		1,900
Telephone expense	1,800
	$73,910

Data used for cost distribution follow:

Cost Center
	A	B	C
Cubic feet	600,000	200,000	200,000
Square feet of floor space	48,000	6,000	6,000
Number of telephone extensions	9	27	9

Three-fourths of the furniture and fixtures are in Cost Center B and one-fourth is in Cost Center C. Half of the inventory is in Cost Center A and half is in Cost Center B. Assume that all building costs except utilities arc allocated on the basis of floor space. Utilities are allocated based on cubic feet. All machinery and equipment are in Cost Center A.

Required:

Calculate the amount of cost to be allocated to each cost center.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).

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

a. Their effect on individual product costs?

b. Their effect on total company profits? (Assume no changes in any operating decisions, such as prices and production volumes.) If there are material differences, why do they exist? If there are no material differences, why do they not exist?

3. What should Will do now? Explain.