Problem 1 Aunt Ethels Fancy Cookie Company Manufactures And

Problem 1 Aunt Ethels Fancy Cookie Company Manufactures And Sells Th

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?

Paper For Above instruction

Aunt Ethel’s Fancy Cookie Company faces the common challenge of accurately determining product costs and profitability across its three cookie varieties: macaroon, sugar, and buttercream. Proper cost allocation is critical for strategic decision-making, pricing, and improving overall profitability. This paper explores activity-based costing (ABC) versus traditional costing systems within this context, calculating specific overhead costs and profits per 1,000 cookies, and evaluating which system provides a more precise picture of profitability.

Introduction

Cost management is essential for manufacturing companies striving to optimize profits and maintain competitive pricing. Traditional costing assigns overhead based primarily on direct labor hours, assuming a proportional relationship between labor and overhead. Conversely, activity-based costing (ABC) aims to allocate overhead more accurately by considering multiple activities that drive costs. Understanding the differences between these systems is vital for companies like Aunt Ethel’s, which produces multiple flavors with distinct resource consumption patterns.

Activity-Cost-Driver Rate for Packaging Costs

The first step involves calculating the activity-cost-driver rate for packaging. As per the data, total packaging overhead costs amount to $150,000, with total activity levels at 950 hours (0.5 hours per 1,000 cookies for each flavor, total of three flavors and projected sales in units). The packaging activity level for the entire production is calculated based on the number of cookies:

Total packaging hours = 0.5 hours × (500,000 + 1,000,000 + 500,000) cookies = 0.5 hours × 2,000,000 cookies = 1,000,000 hours.

However, given the projected sales, the total packaging hours can be more precisely linked to the number of units:

Total packaging hours for projected sales = 0.5 hours × 1,000 units per flavor × 3 flavors = 1,500 hours.

But considering the activity levels provided, the total overhead assigned to packaging is $150,000, and activity level is 1,900 hours; hence, the activity-cost-driver rate for packaging is:

Rate = Total packaging overhead / Total activity level hours = $150,000 / 1,900 hours ≈ $78.95 per hour.

Estimated Overhead Costs Per 1,000 Cookies Using ABC System for Sugar Cookies

Using activity-based costing, overhead is allocated based on the specific activities that drive costs. According to the data, sugar cookies require 1,000-unit batches with 1 hour of oven use, 1 hour of direct labor, and 0.5 hours of packaging.

The relevant activity consumption for sugar cookies:

• Oven activity: 1 hour per 1,000 cookies
• Direct labor: 1 hour per 1,000 cookies
• Packaging: 0.5 hours per 1,000 cookies

Overhead costs allocated:

• Oven: (1,900 hours / 1,900 hours total) × $120,000 = allocated proportionally based on activity levels.
• Packaging: 0.5 hours × (Total overhead for packaging / total packaging hours).

  Given the total packaging activity level of 1,900 hours and overhead of $150,000, the rate is approximately $78.95 per hour as calculated earlier. Thus, packaging overhead per 1,000 sugar cookies = 0.5 hours × $78.95 ≈ $39.48.

Similarly, oven overhead allocation:

Oven overhead for sugar cookies = (1 hour / 1,900 hours total) × $120,000 ≈ $63.16

Total overhead for sugar cookies = $63.16 (oven) + $39.48 (packaging) ≈ $102.64 per 1,000 cookies.

Estimated Operating Profit per 1,000 Sugar Cookies Using ABC

Calculations involve revenue per 1,000 cookies minus variable costs and allocated overhead. Selling price per unit of sugar cookies is $0.60, so revenue for 1,000 units:

Revenue = 1,000 units × $0.60 = $600.

Variable costs:

• Direct materials = 1,000 × $0.14 = $140
• Direct labor = 1,000 × $0.02 = $20

Total variable costs = $160.

Contribution margin = $600 – $160 = $440.

Operating profit = Contribution margin – allocated overhead:

= $440 – $102.64 ≈ $337.36.

Using Traditional Cost System for Overhead Allocation

In the traditional approach, overhead is allocated based on direct labor hours. Total direct labor hours are given as 2,400 hours for the year. It is assumed that overhead is proportional to direct labor hours.

Overhead rate = Total overhead / Total direct labor hours = $270,000 / 2,400 hours = $112.50 per labor hour.

For sugar cookies, which require 1 hour per 1,000 units, the overhead per 1,000 cookies is:

$112.50 × 1 hour = $112.50.

Operating Profit per 1,000 Sugar Cookies Using Traditional System

Revenue remains the same at $600. Variable costs are unchanged at $160. Overhead allocated:

$112.50 per 1,000 cookies.

Operating profit = $600 – $160 – $112.50 = $327.50.

Comparison and Analysis

The traditional system estimates profit at approximately $327.50 per 1,000 cookies, whereas the ABC system estimates a profit of around $337.36. The difference stems from the allocation method: traditional costing generally over-allocates overhead to products consuming more direct labor hours, which may not accurately reflect actual resource consumption. ABC provides a refined view by distributing costs based on specific activities directly associated with each product. In this case, the ABC method shows a slightly higher profit margin, indicating that sugar cookies may consume fewer overhead resources relative to other products than the traditional method suggests.

Conclusion: Which System Offers Better Profitability Estimates?

Activity-based costing offers a more precise understanding of how overhead costs are driven by specific activities related to each product. It minimizes cost distortion caused by averaging overhead uniformly across products based solely on labor hours. Therefore, ABC provides better insights into true profitability, enabling managers to make more informed strategic decisions such as pricing, product line adjustments, or process improvements. For Aunt Ethel’s, adopting ABC could lead to more accurate product costing, identify unprofitable lines, or optimize resource allocation.

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