PEI Potatoes processes potatoes into potato cuts at its highly automated plant. For many years, it processed potatoes for only the retail consumer market where it had a superb reputation for quality. Recently, it started selling potato cuts to the institutional market, which includes hospitals, cafeterias, and university dormitories. Its penetration into the institutional market has been slower than predicted.

PEI's existing costing system has a single direct cost category (direct materials, which are the raw potatoes) and a single indirect cost pool (production support). Support costs are allocated on the basis of kilograms of potato cuts processed. Support costs include packaging material. The 2015 total actual costs for producing 1,000,000 kilograms of potato cuts (900,000 for the retail market and 100,000 for the institutional market) are:

Direct materials used....................$ 250,000

Production support......................1,298,000

The existing costing system does not distinguish between potato cuts produced for the retail or the institutional markets.

At the end of 2015, PEI unsuccessfully bid for a large institutional contract. Its bid was reported to be 30% above the winning bid. This came as a shock, as PEI included only a minimum profit margin on its bid. Moreover, the PEI plant was widely acknowledged as the most efficient in the industry.

As part of its lost contract bid review process, PEI decided to explore several ways of refining its costing system. First, it identified that $260,000 of the $1,298,000 pertains to packaging materials that could be traced to individual jobs ($238,000 for retail and $22,000 for institutional). These will now be classified as a direct material. The $250,000 of direct materials used were classified as $225,000 for retail and $25,000 for institutional. Second, it used activity-based costing (ABC) to examine how the two products (retail potato cuts and institutional potato cuts) used the support area differently. The finding was that three activity areas could be distinguished and that different usage occurred in two of these three areas. The indirect cost per kilogram of finished product at each activity area is as follows:

Activity AreaRetail Potato CutsInstitutional Potato Cuts

Cleaning......................$0.18..................................$0.18

Cutting..........................0.30....................................0.20

Packaging labour..............0.60....................................0.28

There was no beginning or ending amount of any inventory (materials, work-in-process, or finished goods).

Required

1. Using the current costing system, what is the cost per kilogram of potato cuts produced by PEI?

2. Using the refined costing system, what is the cost per kilogram of (a) retail market potato cuts, and (b) institutional market potato cuts?

3. Comment on the cost differences shown between the two costing systems in requirements 1 and 2. How might PEI use the information in requirement 2 to make better decisions?