Polzin Corporation produces two grades of wine from grapes that it buys from California growers. It produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called Cool Day. It sells this in 600,000 5-liter jugs. Polzin also produces and sells roughly 300,000 liters per year of a low-volume, high-cost product called Lite Mist. Lite Mist is sold in 1-liter bottles. Based on recent data, the Cool Day product has not been as profitable as Lite Mist. Management is considering dropping the inexpensive Cool Day line so it can focus more attention on the Lite Mist product. The Lite Mist product already demands considerably more attention than the Cool Day line.
Greg Kagen, president and founder of Polzin, is skeptical about this idea. He points out that for many decades the company produced only the Cool Day line, and that it was always quite profitable. It wasn't until the company started producing the more complicated Lite Mist wine that the profitability of Cool Day declined. Prior to the introduction of Lite Mist, the company had simple equipment, simple growing and production procedures, and virtually no need for quality control. Because Lite Mist is bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and box than does Cool Day. The company must bottle and handle 5 times as many bottles of Lite Mist to sell the same quantity as Cool Day. Cool Day requires 1 month of aging; Lite Mist requires 1 year. Cool Day requires cleaning and inspection of equipment every 10,000 liters; Lite Mist requires such maintenance every 600 liters.
Greg has asked the Accounting department to prepare an analysis of the cost per liter using the traditional costing approach and using activity-based costing. The following information was collected.
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CoolDay
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LiteMist
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Direct materials per liter
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$0.40
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$1.20
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Direct labor cost per liter
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$0.25
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$0.50
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Direct labor hours per liter
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0.05
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0.09
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Total direct labor hours
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150,000
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27,000
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Activity Cost Pool
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Cost Driver
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Estimated Overhead
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Expected
Use of
Cost Drivers
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Expected Use of
Cost Drivers per Product
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CoolDay
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LiteMist
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Grape processing
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Cart of grapes
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$145,860
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6,600
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6,000
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600
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Aging
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Total months
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396,000
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6,600,000
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3,000,000
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3,600,000
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|
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Bottling and corking
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Number of bottles
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270,000
|
|
900,000
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600,000
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300,000
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|
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Labeling and boxing
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Number of bottles
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189,000
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|
900,000
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600,000
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300,000
|
|
|
Maintain and inspect equipment
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|
Number of inspections
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240,800
|
|
800
|
|
350
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|
450
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| |
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$1,241,660
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Write a memo to Greg Kagen discussing the implications of your analysis for the company's plans. In this memo provide a brief description of ABC, as well as an explanation of how the traditional approach can result in distortions. Refer to P4-4A (a-d).