From the Ground Up Inc. (FGU) is a distributor and processor of a variety of different brands of coffee. The company buys coffee beans from around the world and roasts, blends, and packages them for resale. FGU currently has 15 different coffees that it offers to gourmet shops and restaurants in one-kilogram bags. The major cost is direct materials; however, there is a substantial amount of factory overhead in the predominantly automated roasting and packing process. The company uses relatively little direct labour.

Some of the coffees are very popular and sell in large volumes, while a few of the newer brands have very low volumes. FGU prices its coffee at full product cost, including allocated overhead, plus a markup of 25%. If prices for certain coffees are significantly higher than the market, the prices are lowered. The company competes primarily on the quality of its products, but customers, especially restaurants, are price conscious as well.

Data for the 20X9 budget includes factory overhead of $5,000,000, which has been allocated in the company's current costing system on the basis of each product's direct labour cost. The budgeted direct labour cost for 20X9 is $500,000. Budgeted purchases and use of direct materials (mostly coffee beans) will total $8,000,000.

Budgeted direct costs for one-kilogram bags of two of the company's products (Colombian Roast, a popular, high-volume product, and Peruvian Blend, a more specialized, low-volume coffee) are as follows:

ColumbianPeruvian

RoastBlend

Direct materials $2.28 $2.84

Direct labour $0.20 $0.20

FGU's controller believes the current traditional product costing system may be providing misleading cost information. He has developed the following analysis of the 20X9 budgeted factory overhead costs:

ActivityCost DriverBudgetedBudgeted

ActivityCost

PurchasingPurchase order (PO)3,187$637,400

Materials handlingMachine movements1,500675,000

Quality controlBatches500170,000

GrindingGrinding hours50,000850,000

RoastingRoasting hours110,0001,100,000

BlendingBlending hours18,920567,600

PackagingPackaging hours40,0001,000,000

$ 5,000,000

Data regarding the 20X9 production of Colombian Roast and Peruvian Blend coffee follow. There are no beginning or ending direct materials inventory for either of these coffees.

Columbian RoastPeruvian Blend

Budgeted sales200,000 kg2,500 kg

Batch size10,000 kg500 kg

Machine movements3 per batch3 per batch

Purchase order size5,000 kg250 kg

Grinding time2 hours per 100 kg2.5 hours per 100 kg

Roasting time1 hour per 100 kg1 hour per 100 kg

Blending time0.5 hours per 100 kg0.5 hours per 100 kg

Packaging time0.1 hours per 100 kg0.1 hrs per 100 kg

:

a)Using FGU's current traditional product costing system, do the following:

i. Determine the company's predetermined overhead rate (POR) using direct labour cost as the single cost driver.

ii. Determine the full product costs and selling prices for one kilogram each of Colombian Roast and Peruvian Blend coffee.

b)Using an activity-based costing approach, develop a new product cost and price for one kilogram each of Colombian Roast and Peruvian Blend coffee.

c)FGU has recently seen sales of their traditional very popular Columbian roast decline but sales of the new Peruvian Blend has started to show good growth. Based on your calculations, would you change your pricing strategy? Explain.