Ace Fertilizer Company: Ethical Cost Allocations and Price Determination
Introduction
Having a double undergraduate major in Accounting and Integrated Supply Management and an MBA from a renowned business school qualified Abby Conroy, CMA, for her position at Ace Fertilizer Company. She has been employed at Ace Fertilizer for the past three years, and is a highly respected employee. Her hard work and dedication to detail resulted in a series of rapid promotions. Currently, Abby is assistant director of manufacturing and is primarily responsible for special customer orders. Meeting the needs of customers in manufacturing special orders has become a very profitable portion of Ace’s operations. These special orders sometimes complement, but
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The wages of general production employees who are idled due to machine breakdown are classified as indirect costs. Direct costs are usually variable and change as production volumes change. Thus, direct materials and direct labor are typically variable costs. For special orders, some direct costs can be fixed, however. The costs (depreciation, electricity, and routine maintenance) associated with a machine dedicated to one product are direct costs of that product. Indirect costs cannot be easily and conveniently assigned to a special order. Rather, these costs are common costs, in that they are incurred to produce a variety of special orders. Maintenance costs of general purpose equipment, the supervisor’s salary, and utilities are direct costs needed to produce special orders in general, but are indirect costs for a particular special order. Moreover, general production costs, including property taxes, insurance, lawn care, cafeteria costs, and miscellaneous supplies consumed in production are indirect costs properly allocated to special orders manufactured.
Allocation of Indirect Costs
Abby could allocate indirect costs to special orders using a company-wide overhead rate. Frequently, these indirect costs are allocated by selecting an allocation base common to all of the company’s products or services. Many companies base overhead allocations on direct labor-hours
Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.
choose the most appropriate and effective overhead rate, particularly, because it guides management in its tasks of product pricing, job costing, and budgeting. Businesses can use the single company-wide method or can opt for the departmental method. Auerbach
The current cost system allocates overhead costs once a year, as a function of direct labor dollars. This allocation strategy results in:
Wilkerson employs a Normal Cost System, which means that they use predetermined overhead rates along with actual costs for direct material and direct labor. Normal costing systems are appropriate when overhead costs are a relatively small percentage of total manufacturing costs and product diversity is limited. For Wilkerson, normal costing does not make sense. Overhead costs make up over 50 percent of total manufacturing costs and their product offering is relatively more diverse. This indicates that the current accounting system in place may be distorting costs significantly. Supporting data:
In other words, the direct cost is a direct relationship with the production process, while the indirect costs are not a direct relationship with the production process, the cost of services in the production process. Within a period of total indirect costs are essentially constant, it is also known as fixed costs and indirect costs. Although its total output within a certain range does not substantially change with production, but allocated to indirect costs per unit of product decreases with the increase in production. For example, a company produced can food. Each food cans have direct costs, including the cost of ingredients, pots, you can label, wages involved in the production of canned food, canned and tag content of workers and machinery in the process of actual power consumption. There are also indirect costs including multi pack packaging; administrative costs, including salaries of administrative and management personnel, equipment, etc.; premises rented; total power utility costs and other buildings, as well as marketing and
Overhead costs include rent, office staff, depreciation, and other. Once the flexible budget was complete, variances between the actual and flexible budget could be calculated (Exhibit B). The variance for frame assembly was favorable with actual costs being $82,663 less than in the flexible budget. The variances for wheel and final assembly however were both unfavorable. Wheel assembly had an unfavorable variance of $50,650, while final assembly variance was the highest at an unfavorable variance of $231,200. Taking into account these three aspects of direct cost, direct cost has an unfavorable variance $199,187. Although most overhead costs are fixed, 2/3 of other costs are variable and increase with the increased production. As shown in Exhibit B, overhead variance is unfavorable at $60,000. The direct cost variance and overhead variable together lead to a total unfavorable variance of $259,187.
ML had developed a policy of selling manual machines and renting automatic machines. Manual machines did not cost much, did not require service, and could be modified to attach different fasteners inexpensively. Automatic machines were rented on an annual basis because they would have been more expensive to sell and it provided annual income to ML. However, about 700 of the rented machines were returned each year. During the time that machines were in inventory, ML would modify the machines to attach different fasteners. This was expensive with an average cost per modification of $2000. If all 700 machines were modified during a given year this would have cost $1.4 million per year. It was also industry practice to provide preventative maintenance and
Under the existing cost system for the turning machine area, there are two direct costs and three cost pools for overhead costs. The two direct costs are simply Direct Labor and Direct Material, which are traced to the cost object, which is Machine Parts. The total overhead is split into three cost pools, which are the following: overhead applied on direct labor, overhead applied on material dollars, and overhead applied on ACTS machine hours. Furthermore, each cost pool is broken down into direct and period sub categories. The mentioned cost pools for the following cost drivers: Direct Labor dollars, Material dollars, and machine hours.
Abby Conroy was tasked with calculating an effective quote for Breeland Ltd., she chose the activity based accounting costing system since it more accurately captures the related costs. A special order was placed by Breeland Ltd. with Ace Fertilizer Company. The did not plan to order more of this product in the future. Based on Ace’s policy, the special order included disposal costs for any used materials in the event no other orders existed for the unused materials at the time the Breeland contract was signed. Abby correctly calculated the total direct material and labor costs and accurately arrived at the indirect costs using the ABC method and used cost activity pools that make sense for the company and
As per the cost structure given in the case, Selling costs, Sales and Administration costs, Depreciation and other manufacturing overheads have been considered to be variable costs, i.e. per unit costs and hence have been accounted for in the calculation of profit and loss. As such, this methodology is resulting in a loss of $900 for every Sunday that the plant is operated. Therefore, if the present cost structure is used no production should be done on Sunday since it is clearly unprofitable.
Manufacturing overhead Rent on production equipment........ $ 6,000 Insurance on factory building ....... 1,500 Depreciation on factory building............................................ 1,500 Utility costs—factory........................ 900 Property taxes on factory building............................................ 400 Miscellaneous expenses— factory .............................................. 1,000 Total manufacturing costs..................... Total cost of work in process ...............
Based on the explanation on page 201 below are the details of each cost and respective category:
Taylor has asked Swift to submit a bid for a 25 000 kilogram order of the private brand
Manufacturing companies almost always incur variable expenses. A big reason why is because to make products, you need raw materials. In this case we have Fly Ash (250,000), Gypsum (250,000), Lime (300,000) and Sand (40,000). Another variable expense will be Workers Labor (100,000) and Drivers (25,000). The workers will be working varying hours depending upon the production need. During busy times they might be working overtime, while in down times they could very well be asked to not come in for a day. This is all under the assumption that they are paid hourly and not on salary. If they were salaried it would be considered a fixed cost. The same goes with the drivers. They will be delivering the products on a demand basis. More trips when the company is busy and less when production is slow.
First, we have identified if there is really an insufficiency in the amount of selling prices set by the Sales Department, in reference to Exhibit 1 of the case. We did this through identifying the maximum amount of overhead costs that the company can incur for the three products and comparing it with the total overhead costs. See Table 1 for details.