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    Activity Based Cost case study

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    The Grape Cola caper. Howard Rockness was worried. His company, Rockness Bottling, showed declining profits over the past years despite an increase in revenues. With profits declining and revenues increasing. Rockness knew there must be a problem with costs.

    Rockness sent an email to his executive team under the subject heading, " How do we get Rockness Bottling back on track?" Meeting in Rockness's spacious office, the team began brainstorming solutions to the declining profit problems. Some members of the team wanted to add products. ( these were marketing people.) Some wanted to fire the least efficient workers. (These were finance people.) Some members of the team wanted to empower the workers. (These people worked in the Human Resources Department.) And some people wanted to install a new computer system. (It should br obvious who these people were.)

    Rockness listened patiently. When all participant made their cases, Rockness said, we made money when we are a smaller, simpler company. We have grown, added new products to old product lines. Now we are going downhill. What is wrong with this picture?"

    Rockness continued "Here look at this report. This is last month's report on the cola bottling line. What do you see here? He handed copies of the report in Exhibit 3.10 to the people in his office.

    Rockness asked, do you see any problems here? Should we drop any of theses products? Should we reprice any any of these products?" the room was silent for a moment, then everybody started to talk at once. Nobody could see any problems based on the data in the report, but all made suggestions to Rockness is ranging from "Add another cola product" to cut costs across the board" to "we need a new computer system so that managers can get this information quickly." A not-so-patient rockiness stopped the discussion abruptly and adjourned in the meeting.

    He then turned to the quickest person in the room- his son, Rocky - and said. "I am suspicious of these cost data, Rocky. Here we are assigning indirect costs to these products using a 260 percent rate. I really wonder whether that rate is accurate for all products. I want you to dig into the indirect cost data. Figure out what drives those costs and see whether you can give me more accurate cost these products." "Will do. Dad."

    Exhibit 3.10
    Monthly Bottling on cola Bottling Line

    Diet Regular Cherry Grape Total
    Sales $75,000 $60,000 $13,950 $1,650 $150,600
    Less:
    Materials 25,000 20,000 4,680 550 50,230
    Direct Labor 10,000 8,000 1,800 200 20,000
    Fringe Benefits on Direct Labor 4,000 3,200 720 80 8,000
    Indirect costs @ 260% of direct labor 26,000 20,800 4,680 520 52,000
    Gross Margin $10,000 $8,000 $2,070 $300 $20,370
    Return on sales 13.30% 13.30% 14.80% 18.20% 13.50%
    Volume 50,000 40,000 9,000 1,000 100,000
    Unit Price $1.5 $1.5 $1.55 $1.65 $1,506
    Unit Cost 1.3 1.3 1.32 1.35 1.302

    Return on sales before considering selling, general and administrative expenses.

    Rocky first went to the accounting records to get a breakdown of indirect costs. Here is what he found:

    Column1 Column2 Column3
    Indirect labor $20,000
    Fringe benefits on indirect labor 8,000
    Information Technology 10,000
    Machinery depreciation 8,000
    Machinery maintenance 4,000
    Energy 2,000
    Total $52,000

    Then he began a series of interviews with department heads to see how to assign these costs to cost pools. He found that one-half of indirect labor was for scheduling or for handling production runs. Including purchasing, preparing the production run. Releasing materials for the production run, and performing a first-time inspections of the run. Another 40 percent of indirect labor was used to set up machinery to produce a particular product. The time to set up to products varied, with the least time for cola and the most for Cherry and Grape. The remaining 10 percent of indirect labor was spent maintaining records for each of the four product, monitoring the supply of raw materials required for each product, and improving the production processes for each product.

    Interviews with people in the Information Technology Department indicated that $10,000 was allocated to the cola bottling line. Eight percent of this $ 10,000 information technology cost was for scheduling productions runs. Twenty percent of the cost was for record keeping for each of the four product.

    Fringe benefits were 40 percent of labor costs. The rest of the overhead was used to supply machine capacity of 10,000 hours of productive time.

    Rocky then found the following cost driver volumes from interviews with production personnel.

    ? Setups: 560 person hours doing setups
    ? Production runs: 110 production runs
    ? Number of products: 4 products
    ? Machine hour capacity: 10,000 hours

    Diet cola used 200 setup hours, 40 production runs, and 5,000 machine hours to produce 50,000 units. Regular cola used 60 setup hours, 30 production runs and 4,000 machine hours to produce 40,000 units. Cherry cola used 240 setup hours, 30 production runs, and 900 machine-hours to produce 9,000 units. Grape cola used 60 setup hours, 10 production runs, and 100 machine hours to produce 1,000 units. Rocky learned that production people had difficulty getting the taste just right for the cherry and grape cola, so Cherry and Grape cola required more time per setup than either Diet or Regular cola did.

    a. Compute cost driver rates for each of the four cost driver
    b. Compute unit costs for each product: Diet, Regular, Cherry and Grape colas.
    c. Prepare a report like the one in Exhibit 3.10 but with your revised indirect cost numbers for each product.
    d. Prepare a memorandum to (Howard ) Rockness recommending what to do.

    45. The Grape cola caper: unused capacity. Assume that all facts in case 44 still hold except that the practical capacity of the machinery was 20,000 hours instead of 10,000.

    a. Recompute the unit costs for each product: Diet, Regular, and Grape colas.
    b. What is the cost of unused capacity? What do you recommend that Rockness Bottling do with this unused capacity?
    c. Now assume that Rockness production a fifth product: Vanilla cola. Because Vanilla cola is in high demand in the

    Rockness Bottling`s market, assume that it would use 10.000 hours of machine time to make 100.000 units. (Recall that the machine capacity in this case is 20.000 hours, while Diet, Regular, Cherry, and Grape consume only 10.000 hours) Vanilla cola`s per-unit costs would be identical to those of Diet cola except for the machine usage costs. What would be the cost of Vanilla cola? Calculate on a per-unit basis, then in total.

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