Problem 1: Aunt Ethel's Fancy Cookie Company Manufactures
Problem 1 Aunt Ethels Fancy Cookie Company Manufactures And Sells T
Determine the activity-cost-driver rate for packaging costs. Using the ABC system, for the sugar cookie, compute the estimated overhead costs per 1,000 cookies. Using the ABC system, for the sugar cookie, compute the estimated operating profit per 1,000 cookies. Using a traditional system (with direct labor hours as the overhead allocation base) for the sugar cookie, compute the estimated overhead costs per 1,000 cookies. Using a traditional system (with direct labor hours as the overhead allocation base) for the sugar cookie, compute the estimated operating profit per 1,000 cookies. Explain the difference between the profits obtained from the traditional system and the ABC system. Which system provides a better estimate of profitability? Why? Problem 2: What is activity-based management and how can it be used to improve the profitability of a company?
Paper For Above instruction
Activity-Based Costing (ABC) and traditional costing methods are essential tools for managerial decision-making, enabling organizations to better understand and improve profitability. In this analysis, we will explore the application of ABC to Aunt Ethel's Fancy Cookie Company, focusing on calculating overhead costs and operating profits for sugar cookies, and compare these methods with traditional costing. Additionally, we will discuss activity-based management and its role in enhancing company profitability.
Activity-Cost-Driver Rate for Packaging Costs
To determine the activity-cost-driver rate for packaging costs, we analyze the total packaging overhead and the activity level. The total packaging costs are estimated at $150,000, with an activity level of 1,900 hours dedicated to packaging activities. The activity-cost-driver rate is calculated as follows:
\[ \text{Packaging Cost Driver Rate} = \frac{\text{Total Packaging Overhead}}{\text{Total Packaging Hours}} = \frac{\$150,000}{1,900 \text{ hours}} \approx \$78.95 \text{ per hour} \]
This rate indicates the cost incurred for each hour of packaging activity, allowing precise allocation to each product based on actual usage.
Estimated Overhead Costs per 1,000 Sugar Cookies Using ABC
Using ABC, overhead costs are allocated based on the activity levels specific to the sugar cookies. The key activities are direct labor, oven use, and packaging, with respective activity levels for sugar cookies being proportional to their batch sizes.
For sugar cookies:
- Direct labor hours: 1 hour per 1,000 cookies
- Oven hours: 1 hour per 1,000 cookies
- Packaging hours: 0.5 hours per 1,000 cookies
Applying the activity rates:
- Direct labor overhead rate: \(\frac{\$270,000}{2,400 \text{ hours}}\approx \$112.50 \text{ per hour}\)
- Oven overhead rate: \(\frac{\$120,000}{1,900 \text{ hours}}\approx \$63.16 \text{ per hour}\)
- Packaging overhead rate: \$78.95 per hour (from previous calculation)
Total overhead for sugar cookies:
- Direct labor overhead: \(1 \text{ hour} \times \$112.50 = \$112.50\)
- Oven overhead: \(1 \text{ hour} \times \$63.16 = \$63.16\)
- Packaging overhead: \(0.5 \text{ hour} \times \$78.95 = \$39.48\)
Total estimated overhead cost per 1,000 sugar cookies:
\[
\$112.50 + \$63.16 + \$39.48 = \$215.14
\]
Estimated Operating Profit per 1,000 Sugar Cookies Using ABC
Calculating operating profit involves subtracting total costs from revenues:
- Selling price per 1,000 sugar cookies: \(500 \times \$0.75 = \$375\)
- Direct materials: \(500 \times \$0.15 = \$75\)
- Direct labor: \(500 \times \$0.02 = \$10\)
- Overhead (ABC): \$215.14
Total costs:
\[
\text{Materials} + \text{Labor} + \text{Overhead} = \$75 + \$10 + \$215.14 = \$300.14
\]
Operating profit:
\[
\$375 - \$300.14 = \$74.86
\]
Thus, the estimated operating profit for 1,000 sugar cookies using ABC is approximately \$74.86.
Estimated Overhead Costs per 1,000 Sugar Cookies Using Traditional System
The traditional overhead allocation uses direct labor hours as the base. Total direct labor hours are 2,400, with total overhead being \$270,000.
The overhead rate per labor hour:
\[
\frac{\$270,000}{2,400 \text{ hours}} = \$112.50 \text{ per hour}
\]
For sugar cookies:
- Direct labor hours: 1 hour per 1,000 cookies
- Overhead allocated: \(1 \text{ hour} \times \$112.50 = \$112.50\)
Total estimated overhead costs:
\[
\$112.50
\]
Estimated Operating Profit per 1,000 Sugar Cookies Using Traditional System
Using the same revenue and cost data as before:
- Revenue: \$375
- Materials: \$75
- Labor: \$10
- Overhead (traditional): \$112.50
Total costs:
\[
\$75 + \$10 + \$112.50 = \$197.50
\]
Operating profit:
\[
\$375 - \$197.50 = \$177.50
\]
Comparison and Explanation of Profitability Differences
The significant difference in profit estimates highlights the limitations of traditional costing. The traditional method assigns overhead based solely on direct labor hours, which assumes uniformity in resource consumption across products. However, as seen, the ABC system apportions costs more precisely according to the actual activities and resource usage for sugar cookies. In this case, the ABC system indicates lower overhead costs (\$215.14 vs. \$112.50) and, consequently, a lower profit estimate (\$74.86 vs. \$177.50).
This discrepancy underscores the potential for traditional systems to overstate or understate profitability, especially when products differ significantly in their resource consumption. ABC provides a more accurate picture by allocating costs based on activities that drive costs, leading to better-informed managerial decisions regarding pricing, product mix, and process improvements.
Which System Provides a Better Estimate of Profitability and Why?
The ABC system offers a superior estimate of product profitability because it assigns overhead costs more accurately according to the activities that incur those costs. Traditional systems tend to oversimplify overhead allocation, often leading to distorted profit margins, especially in diversified product lines with varying resource usage.
By capturing the complexity of activities and resource consumption, ABC helps managers identify high-cost activities, inefficiencies, and opportunities for process improvement. It enables more precise product costing, aiding in strategic decisions such as pricing, product discontinuation, or process redesign, thereby enhancing overall profitability.
Problem 2: Activity-Based Management and Profitability Improvements
Activity-Based Management (ABM) extends from Activity-Based Costing by using detailed activity information to manage business processes proactively. ABM involves analyzing activities to identify non-value-added operations and eliminate or optimize them, aligning activities with organizational goals to enhance efficiency and profitability (Cooper & Kaplan, 1988).
ABM can improve profitability through several mechanisms:
- Cost Reduction: By pinpointing inefficient activities, organizations can streamline processes, reduce costs, and improve margins. For instance, reducing waste or automating repetitive tasks directly lowers operating expenses.
- Process Improvement: Understanding activity drivers enables redesigning processes for better resource utilization, faster turnaround times, and higher quality, all contributing to increased customer satisfaction and sales.
- Pricing and Product-Mix Optimization: Accurate activity-based information helps determine true product costs, enabling competitive pricing strategies and focus on high-margin products.
- Strategic Decision-Making: ABM supports decisions such as outsourcing, process redesign, and product development by providing a clear view of activity costs and benefits.
In the context of Aunt Ethel’s Cookie Company, applying ABM would entail analyzing each activity—baking, packaging, marketing—and identifying activities that do not add value or incur excessive costs. For example, if packaging activities are disproportionately expensive due to inefficient procedures, streamlining these could significantly improve profitability. Additionally, ABM can reveal whether the current resource allocation aligns with actual product profitability, guiding strategic focus on profitable product lines or markets.
By systematically analyzing and managing activities, companies can drive continuous improvements, reduce waste, and strategically align resources with profitable activities. Consequently, ABM not only enhances cost management but also supports strategic initiatives that boost long-term profitability (Kaplan & Cooper, 1998).
Conclusion
In conclusion, activity-based costing and management provide valuable insights into the true costs and profitability of products like Aunt Ethel's cookies. While traditional costing systems are simpler and easier to implement, they often lead to distorted profit margins due to their reliance on broad averages. ABC offers a more precise allocation method, leading to better decision-making and improved profitability. Implementing activity-based management further enhances these benefits by focusing on efficiency and value-added activities, ultimately supporting strategic growth and competitiveness in the marketplace.
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