C16.48 Activity-based costing; activity-based management; non-value-added costs; LO16.2 BPR; target costing: manufacturer 16.3 Schmidtke's Meat Pty Lid manufactures smoked meat products In the Barossa Valley, using processes that 16.5 have been handed down from one generation of Schmidtkes to the next. Recently, one of the company's major high-volume products, mettwurst, has come under Intense pressure from an Adelaide manufacturer that uses modern manufacturing processes. Schmidtke's mettwurst sells for $7 per 500-gram stick, based on a cost-plus pricing system. (The company applies manufacturing overhead using a plantwide overhead rate based on the number of direct labour hours worked. Prices are based on absorption cost plus a 40 per cent markup.)The Adelaide competitor sells its mettwurst for $5.50 per 500-gram stick. The owner and manager of Schmidtke's, Hans Schmidtke, Is not particularly worried about the problem, but his wife Frieda, the marketing manager, Is concerned. Frieda: Hans, you are putting your head in the sand. The Adelaide mettwurst has the potential to destroy our business. All our years of work will be lost. By the time our children, Wolfgang and Heldl, finish university there will be no more Schmidtke's Meat! Where will they work? Hans: Frieda, stop worrying. The Adelaide mettwurst will disappear from the market after a while. There Is no way they can be making a profit at that price. Just think about it. They're located In the city where the rates and taxes are very high. They've got all that fancy new machinery to pay for. They're playing games, trying to get a share of our market. To survive In the longer term, they'll have to Increase their price. Anyway, they don't have a recipe like ours that has been in the family for years. And they don't have our reputation for quality. Heldi: Dad, I'm not sure you're right. You should taste this Adelaide mettwurst. There's no problem with their recipe or their quality. The customers know this already and that's why our mettwurst sales are down. At the university, we've been learning about a new costing system called activity-based costing. I'd like to use it to work out what our problem Is. Hans: I've told you, I've told your mother: we don't have a problem, or we won't In the longer term. In the meantime, If you want to waste your vacation playing around with a new costing system that we don't need, go right ahead! Heldi developed an activity-based costing system and Identified the following bill of activities for the production of mettwurst:. Mettwurst: bill of activities Annual volume: 5000 sticks Batch size: 250 sticks Quantity of activity Cost per unit activity Activity driver used driver Annual cost Inspect meat 20 inspections $30 per inspection $ 600 Dispose of substandard meat 500 kilograms $1 per kilogram 500 Move to mincing room 60 barrow-loads $8 per barrow 480 Load mincer* 40 loads $27 per load 1 080 Operate mincer 3000 kilograms $0.50 per kilogram 1 500 Unload mincer* 40 loads $21 per load 840 Move to mixing room 40 barrow-loads $9 per barrow 360 Load mixer* 60 loads $20 per load 1 200 Operate mixer 60 loads $40 per load 2 400 Unload mixer* 60 loads $16 per load 960 Move to packing room 60 barrow-loads $5 per barrow 300 Pack meat into skins 5000 skins $0.50 per skin 2 500 Move to smokehouse 100 trolley-loads $4 per trolley 400 Move to truck 100 trolley-loads $10 per trolley 1 000 Annual cost of all direct labour and $14 120 manufacturing overhead activities Activity cost per unit $ 2.824 Direct material cost per unit 2.160 Cost per unit $ 4.984 * These activities have to be performed more than once per batch because of the limited capacity per machineRequired: 1. Suggest some reasons why the Adelaide company may be able to sell its mettwurst at $5.50 over the longer term. 2. Calculate the cost per stick of mettwurst under the existing absorption costing system. 3. Hans Is convinced that Heldl's activity-based cost for the mettwurst Is wrong. Identify the likely causes of the difference between the absorption cost and the activity-based cost per unit and explain to Hans why the absorption cost is likely to be wrong. (Hint: If you have problems with this you should revisit Chapter 8.) 4. What target cost would Schmidtke's have to set for its mettwurst If it wished to match the Adelaide price and maintain its existing markup? 5. Review the activities Included In the bill of activities and Identify any candidates for elimination as non- value-added activities. For each activity, explain why you consider it to be non-value-added. 6. Suggest possible root cause cost drivers for each of the non-value-added activities. 7. Does Schmidtke's need business process re-engineering or process Improvement to eliminate Its non- value-added activities? Explain. 8. Assume that, by the next year of operations, the company has been able to reduce the cost of the following non-value-added activities by 25 per cent: Inspect meat dispose of substandard meat move to mincing room load mincer unload mincer move to mixing room load mixer unload mixer move to packing room move to smokehouse move to truck. What will be the activity-based cost per unit (Including direct material)? 9. Assuming the activity-based cost calculated In requirement 8, will the company be able to add its 40 per cent markup and compete effectively with the Adelaide mettwurst? If not, what would you recommend