CALIFORNIA CREAMERY, INC.By: Dex Jesson Belleza

Ethel Leigh Chin

Shary Jane Olid

Company Profile

Owned and operated 14 retail ice cream stores throughout Southern California, from San Luis Obispo to San Diego

Sold only the highest quality, ultra premium ice cream and offers 25 different ice cream flavors

Many of the flavors were “exotic” : “Polynesian Fantasy”, “Mango-Lemon Supreme”, and “Multi-Nut Twist”

A few of the exotic flavors sold in low volumes

Sold a few traditional ice cream flavors: Vanilla, Chocolate, Strawberry, and Coffee

Earlier ice cream was produced in the garage of the company’s founder, Will Forgey

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 (2004 budget)

OH spread: A proportion of the direct labor used in the production process

Total direct labor costs for 2004 was $300,000

Charged the overhead to products at a rate of 200% of direct labor costs

All products were sold at the same retail price

Company Profile

Problem Statement

Which costing method should Will use: Traditional or the ABC system, given that

his pricing policy was not accurate as all products were sold at the

same retail price?

ActivityBudgeted Cost

($000)"Driver" of the Activity

Costs

Budgeted Activity Level for the Cost

Driver

Purchasing 80 Purchase orders 909 Material Handling 95 Setups 1,846 Blending 122 Blended hours 1,000 Freezing 175 Freezer hours 1,936 Packaging 110 Packaging machine hours 1,100 Quality control 18 Batches 286 Total manufacturingoverhead costs $600

Exhibit 1

CALIFORNIA CREAMERY, INC.2004 Budgeted Manufacturing Overhead Costs

Exhibit 2

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

Polynesian Fantasy Vanilla

Direct material $2.00/gallon $1.80/gallonDirect labor 1.20/gallon 1.20/gallonBudgeted production and sales 2,000 gallons 100,000 gallonsBatch size 100 gallons 2,500 gallonsSetups 3 per batch 3 per batchPurchase order size 50 gallons 1,000 gallonsBlender time 0.6 hour per 100 gallons 0.3 hour per 100 gallonsFreezer time 1.0 hour per 100 gallons 1.0 hour per 100 gallonsPackaging machine time 0.3 hour per 100 gallons 0.2 hour per 100 gallons

1. a. Will’s old costing method

Earlier calculation...

b. The new costing method (Louise’s suggestion)

Referring to Exhibit 1

50

Cont..

Cont.

2. What are the effects, if any, of changing the company’s 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 cost of each individual product. How CCI allocate its overhead

costs across its product portfolio will have an impact on the

company’s product Mix and pricing strategy. The current costing

method that Will is currently using is simple but not accurate as it

pictures cost the wrong description of the profitability of a product, as

the overhead cost allocation is based on consumption direct labor as

for a product whereas based on the reality overhead cost is created

based on inidividual activities which may or may not directly

proportionate to the direct labor cost.

The ABC method gives both accurate description of the costs

and product’s profitability instead of placing direct labor as the

product base, the ABC method divides the overhead cost into various

activities based on activity’s consumption in producing the product.

(e.g quality overhead costs are allocated based on number of batches

produced)

b. Their effect on total company profits? (assume no changes in any operating decisions, such as prices and production volumes)

As to total company profits, savings can be attributed directly

to

ABC are more noticeable in the form of better priced products than in

reductions of manufacturing cost (traditional). It improves the

bottom line by improving the matter between the selling price and

cost.

If there are material differences, why do they exist?

Yes, there are material differences that exist. Material differences

between the two methods exists because traditional costing allocate

costs based on single volume measure such as direct labor hours,

machine hours, and direct labor cost which seldom meets the cause

and effect criterion desired in cost allocation unlike the ABC which

have the inherent flexibility to provide management decisions

regardingcost activites.

3. What should Will do now? Explain.

CCI involves a wide variety of production of ice cream therefore ABC should be implemented by Will in order to facilitate cost management. Based on the computation, it resulted to a much lower amount of costs as compared to the traditional costing.

The Company's cost is traced by resource drivers and what is actually being done is traced by activity drivers, thus the cost spend by each production can easily be monitored. It can give managers the ability to match resource needs with the available capacity as closely as possibleand hence improving productivity.

The ABC method gives Will the exact cost of each of individualProduct 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 multipleProducts which consume the same overhead, produces in batches which Fulfilled the requirement of using ABC method.

Conclusion

Will should implement the ABC method. The ABC method will be able to help him closely analyse the cost associated with each individual product to improve the manufacturing process and efficiently will increase the company’s profitability.