Reference no: EM131815833

Cravings for Cakes Pty Ltd manufactures a wide range of delicious cakes and pastries. At the annual Christmas party, the company's owner, I.M. Craving, treated his employees to a nostalgic review of the firm's history. He told them:

Twenty years ago we had only three product line-pies, finger buns and lamingtons. We were flat out producing large volumes of each product, using very simple machinery and a lot of hard work.

My, how things have changed! We still make and sell a lot of pies and lamingtons, but we also produce a wide range of low-volume lines, such as Danish pastries, donuts and vanilla slice. I hear you sighing, and no wonder; these low-volume products are a pain in the neck. They are complex to produce and their production runs involve a lot of extra machinery setups and material handling. But the accountants tell me that these speciality lines have wonderful profit margins, so we must not complain.

Craving then outlined the dramatic changes that had occurred within the business over the past 20 years. In the factor he had seen the introduction of computer-controlled mixing machines and delivery performance. Indeed, right across the business, more and more effort had been placed on keeping the customer happy.

However, his speech cast a gloomy shadow across the Christmas festivities when he warned:

Despite all this progress, the company seems to be struggling. Our profits are declining, and if things don't improve over the next few months, this may be our last Christmas together. To survive we must all work very hard. We must focus on increasing sales, particularly of our high-margin specialty products.

The company's management accountant, Ursula B. Bright, has become concerned about the conventional product costing system at Cravings for Cakes. The manufacturing people were also sure that the costing system was distorting product costs.

Required:

1. Describe the changes in cost structure that are likely to have occurred at Cravings for Cakes over the last 20 years, and explain their causes.

2. Do you think that the existing costing system understates or overstates the cost of:

(a) Lamington
(b) Danish pastry

Explain your answers.

3. Explain how activity-based costing could overcome the deficiencies inherent in the existing costing system.

4. What factors should U.B. Bright consider when deciding whether to use:

(a) Simple activity-based costing system to assign manufacturing overhead to products?

(b) Activity-based system that includes both manufacturing overhead and non-manufacturing costs?

(c) Comprehensive activity-based system that includes all product-related costs except direct material?