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Introduction

14 retail ice cream stores are spread throughout Southern California, from San Luis
Obispo to San Diego.It is sold only the highest quality, ultra premium ice cream and
offers 25 different ice cream flavor. Many of the flavors were exotic" likePolynesian
Fantasy, Mango-Lemon Supreme, and Multi-Nut Twist. A few of the exotic flavors
sold in low volumes. California Dreamery Inc also sold a few traditional ice cream
flavors: vanilla, chocolate, strawberry, and coffee. Earlier ice cream was produced in the
garage of the companys founder, Will Forgey.

California creamery Inc use of 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. 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. It is
charged the overhead to products at a rate of 200 % of direct labor costs. All products
were sold at the same retail price.
Problem Analysis
This case provides a simple setting that illustrates activity-based cost (ABC) principles
and the effects that such a system can have. It can be used as an exam case when the
examination period is short. Students who understand ABC principles well can read the
case and answer a basic set of questions in one hour.

Question No. 1
Compute the full production cost (per gallon) of the Polynesian Fantasy and Vanilla
products using:
a) Wills old costing method;
b) The new costing method (Louises suggestion).

Under the old system, the only difference shown between the costs of Polynesian Fantasy
and Vanilla ice creams was due to the $.20 difference in direct material costs (see Table
1). The overhead rate was 200% of direct labor dollars ($600,000 $300,000).
Figure 1: Old System Costs
Polynesian Fantasy
D
M 2.00
DL 1.20
O
H
2.40
5.60

Vanilla
1.80
1.20

1.20 *
200%
2.40
5.40

1.20 *
200%

The new system costs took some calculating. Figure 2 shows the calculation of the cost
driver rates. Figure 3 uses these rates to calculate the product costs. The total costs for
Polynesian Fantasy and Vanilla are $9.07 and $4.64 respectively.
Figure 2: New SystemCalculate cost drivers
Activity
Purchasing
Material
handling
Blending
Freezing
Packaging

Budgeted
Cost
$80,000
95,000
122,000
175,000
110,000

Activity
cost
driver
Purchase orders
Setups

Budgeted Cost driver


activity
rate
909
$88.01
1,846
51.46
Blender hrs
1,000
122.00
Freezer hrs
1,936
90.39
Packaging machine 1,100
hrs
100.00

Quality
18,000
control
Total
mfg 600,000
OH cost

Batches

286
62.94

Figure 3: New SystemCalculate product costs


Polynesian Fantasy
Vanilla
Purchasing
Material
handling
Blending
Freezing
Packaging
Quality
control

(2,000/50) =
3
*
(2,000/100) =
(36 min * 20)
60=
1 hr * 20 =
(18 min * 20)
60 =

40

$3,520.40

60

3,087.76

12
20

1,464.00
1,807.85

600.00

(2,000/100) =

20
1,258.80
TOTAL
OH
$11,738.76
2,000
gallons
TOTAL
OH per
gallon
5.87

(100,000/1,000) =
3
*
(100,000/2,500) =
(18 min * 1,000)
60 =
1 hr * 1,000 =
(12 min * 1,000)
60 =

100

$8,801.00

120

6,175.20

300
1,000

36,600.00
90,390.00

200

20,000.00

(100,000/2,500) =

40
2,517.60
TOTAL
OH
$164,488.80
100,000
gallons
TOTAL
OH per
gallon
1.64

DM
2.00
DL
1.20
Total
cost per
gallon
$9.07

1.80
1.20
Total
cost per
gallon
$4.64

Question No.2
What are the effects, if any, of changing the companys 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. It is 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).

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

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.

Question No.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. Will might usefully take
any of a number of actions, affecting such areas as cost system design, product offerings,
prices and promotions, product designs, and manufacturing processes (e.g., batch sizes).

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
As a conclusion, 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.