ABC, product cost cross-subsidisation. (Intermediate, 30 minutes)

McCarthy Potatoes processes potatoes into potato chips at its highly automated Longford 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 chips to the institutional market that includes hospitals, cafeterias and university halls of residence. Its penetration into the institutional market has been slower than predicted.

McCarthy’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 chips processed. Support costs include packaging material. The 2000 total actual costs for producing 1,000,000 kg of potato chips (900,000 for the retail market and 100,000 for the institutional market) are

The existing costing system does not distinguish between potato chips produced for the retail or the institutional markets.
At the end of 2000, McCarthy unsuccessfully bid for a large institutional contract. Its bid was reported to be 30% above the winning bid.
This came as a shock as McCarthy included only a minimum profit margin on its bid. Moreover, the Longford plant was widely acknowledged as the most efficient in the industry.
As part of its lost contract bid review process, McCarthy decided to explore several ways of refining its costing system. First, it identified that I£188,000 of the 1£983,000 pertains to packaging materials that could be traced to individual jobs £180,000 for retail and [£8,000 for institutional). These will now be classified as a direct material. The £150,000 of direct materials used were classified as [£135,000 for retail and 1%15,000 for institutional. Second, it used activity-based costing (ABC) to examine how the two products (retail potato chips and institutional potato chips) 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 kg of finished product at each activity area is as follows:

REQUIRED 1. Using the current costing system, what is the cost per kg of potato chips produced by McCarthy?
Using the refined costing system, what is the cost per kg of

(a) retail market potato chips, and

(b) institutional market potato chips?
Comment on the cost differences shown between the two costing systems in requirements 1 and 2. How might McCarthy use the information in requirement 2 to make better decisions? njku58

Transcribed Image Text:

Direct materials used Production support I150,000 L983,000