Fairy Flynn Pty Ltd manufactures a wide range of cakes, which it sells to cafes around Sydney. Its business is completely wholesale in that it doesn$$t sell directly to end consumers. The company began operating twenty years ago, starting with only three basic product lines $$ lamingtons, muffins and scones. The operating model was to produce huge volumes of each product line, which required relatively simple machinery.

The company has since expanded its offering to include more complex products, including various tarts, slices, cake portions and danish pastries. The new products allow Fairy Flynn to offer a more diverse range of cakes, helpful when approaching new client cafes. However, despite their general appeal, these newer product lines tend to have lower sales volumes and are more complicated to make. This means the company has to make them in smaller batches, involving more materials handling and extra machinery set$-$ups.

When the company started, the processes were highly labour intensive, with most steps either done by hand or controlled by assembly line workers. However, five years ago, the company overhauled its production process, purchasing automated mixing machines and ovens. This significantly reduced the number of workers required in the factory, particularly those working directly on the products. Also, although the new, computer$-$controlled machines consume more electricity and require more technical maintenance, they can ensure the cakes are produced more efficiently $($with less waste$)$ and have more consistent quality.

Lately, the company$$s management has become increasingly concerned about the company$$s performance, with profitability declining for the last three years. At a recent strategy meeting, the CEO, Josh Blakely, announced that he believed that to address the situation, the company needed to increase sale volumes, particularly of the newer, speciality product lines, which, he stated, have higher profit margins than the traditional products. However, the company$$s accountant Eliza Sewell was not convinced. She suspected that the conventional costing system at Fairy Flynn$,$ which has used a plantwide method of allocating all overhead based on production machine$-$hours, has been distorting product cost estimates.

After the meeting, Eliza began work on designing an activity$-$based costing system for Fairy Flynn$.$ She imagined that this system would help assign all costs to product lines, except for direct materials, which were relatively simple to trace. Based on her analysis of the annual figures from the previous year in the general ledger, she first identified the following cost categories. For each cost category, she then selected a resource driver $($see Table $1).$

She then thought about how activities were organised and divided the company into six activity centres: sales, ordering and dispatch; mixing; filling; baking; packing and warehousing; and factory administration. She then gathered information about the previous year$$s resource drivers used by each of the six activity centres $($see Table $2).$ Within each activity centre, she identified a set of activities involved in making the cakes, using numbers to note their sequence in the overall process. In total, she identified $19$ different activities. She identified an activity cost driver for each activity and estimated the proportion of the activity centre$$s cost it likely consumed $($see Table $3).$ Finally, she gathered information about the total annual estimates of the activity cost drivers and two different product lines that she hoped she could use to demonstrate her ABC system. She chose one of the older products $($muffins$)$ and one of the new lines $($danishes$)($see Table $4).$

In talking with the production manager, she found that it usually takes around $30$ production machine hours to make a batch of muffins and five hours to make a batch of danishes. He also told her that there is approximately $$1\mathrm{.}10$ worth of direct materials in a muffin $($which sells for $$3$ per unit$)$ and $$1\mathrm{.}20$ of direct materials in a pastry $($which sells for $$4).$

Unfortunately, before Eliza could complete her analysis, she fell ill and was not able to return to work. Josh, who had become aware of her suspicions, has enlisted your consulting company to finish her analysis and provide a report. Specifically, he wants to know:

$1.$ Costing system design recommendation: How could Eliza$$s costing system design be further improved? Explain why this would lead to more accurate costs and how this could improve management decision$-$making at the company.

$2.$ ABC implementation: What factors should Fairy Flynn consider when weighing up whether to implement an ABC system $($or not$)$ to estimate the costs of its products? Be specific in relating the benefits, costs and limitations of ABC to the particular features of the client company.

$3.$ Strategic analysis: Based on your analysis, what alternatives could management consider about how the company could improve profitability?