Group Two: Activity-based costing; activity-based management; non-value-added costs; BPR; target costing: manufacturer

Schmidtke's Meat Pty ltd manufactures smoked meat products in the Barossa Valley, using processes that 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 Heidi, 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.

Heidi: 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!

Heidi developed an activity-based costing system and identified the following bill of activities for the production of mettwurst:.

Mettwurst: bill of activities Annual volume: 5 000 sticks Batch size: 250 sticks

ActivityQuantity of activity Cost per unit activity Annual cost

driver used driver

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 3 000 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 5 000 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

manufacturing overhead activities $14 120

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 machine

Required:

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 Heidi'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 nonvalue-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 nonvalue-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?

how to write report for the above ?