I need help with the operations cost system calculations from the attached Dream Chocolate case. I don't even know where to start.

Dream Chocolate Company: Choosing a Costing System Kip R. Krumwiede and W. Darrell Walden As assigned in ACC 350 - Spring 2014 (Makridis) at Arizona State University ABSTRACT: This case is about Salmon River Foods ("D.C."), a small company that makes the Dream Chocolate line of custom-labeled, high-quality candy bars for special events and advertising purposes. Like many small companies, D.C. has an inadequate costing system and needs a much better one as it starts to get bigger orders. In Part A of this case, you will analyze the company's situation, identify relevant information that is presented in a less-structured format, evaluate the pros and cons of different costing approaches, recommend an approach, and suggest ways to implement it. In Part B, you will develop and calculate costs based on your recommended approach. Working through this case will help you to increase your understanding of the costing methods covered in ACC 350 by providing a real-world setting in which to apply your knowledge. Keywords: instructional case; cost accounting; job order costing; process costing; operation costing; activity-based costing; and accounting information systems. INTRODUCTION K ay Johnson sat back in his chair wondering about what he had just done. He accepted a special order from a national supplier of wellness products for 200,000 chocolate bars at a 20 percent discount from the usual price. It was a new type of bar and the customer provided the recipe. The customer also hinted about a second order for 150,000 bars if the first order was successful. Kay sighed and thought, ''I hope we can make a profit on this order, because we are going to have to increase our capacity big-time to fill it. Wish I knew what the cost will be.'' OVERVIEW OF COMPANY Dream Chocolate (D.C.) is the major product line of Salmon River Foods, the spawn of a trip on the Middle Fork of the Salmon River in Boise, Idaho. President Kay Johnson was burned out by 30 years in the food service industry and decided to sell his business and begin anew. Quite by accident, he received a call asking if his new company Salmon River Foods would consider selling Kip R. Krumwiede and W. Darrell Walden are both Associate Professors at the University of Richmond. We thank David E. Stout, Shannon L. Charles, and Nick Fessler for helpful comments. We also thank Kay Johnson, owner of Dream Chocolate, for his support throughout the project. This case is based on a real company, but quantitative information used in the case is disguised for condentiality purposes. 1 2 Krumwiede and Walden chocolate bars. Kay's son Rob was employed by a German company and was frequently ying to Europe and returning with wonderful chocolate as family gifts. Kay wondered how he could produce European-style chocolate (no waxes or preservatives) in the U.S. With his son's help, he found a supplier in Germany who would ship to the U.S. Kay purchased a chocolate factory in Boise and began production in April 2002. Kathleen Wasson, Vice President, oversees the creative arts department and assists Kay in managing the plant. What started with one basic milk chocolate bar has grown to include two milks, two darks, two semi-sweets, one white, one bittersweet, and other adaptations involving various ingredients such as coffee, berries, and fresh mint. The chocolate is wonderful, but the real charm of the product is its custom labeling. For individual snacking, D.C. bars are sold in specialty markets, ne gift stores, and other locations. They are also available for corporate events and celebrations, such as weddings and birthdays. The website at www.dreamchocolate.com provides more information about its various product offerings. Competitive Pressures D.C. is a small company trying to survive in an industry with many players. Competition can come from the many custom chocolate bar providers on the Internet (e.g., Custom Candy Creations, Totally Chocolate, Carson Wrapped Hershey's Chocolates, to name a few), as well as from big chocolate companies (e.g., Mars, Nestle, and Hershey's) who can always beat D.C. on price. As such, it pursues any type of order it can get. The company's niche is European-style custom chocolate bars and labeling, and it is known for its exibility and speed. For instance, a small customer order can be printed, labeled, and ready for pickup or shipping within an hour if the company already has the label in its system. Few, if any, of D.C.'s competitors can match this turnaround time or its combination of high-quality bars, variety of avors, and custom labeling. Lagging Sales Sales were about $500,000 in 2010. Demand was increasing in August and September 2010, which are normally weaker months due to fewer special events. This gave D.C. management great hope, but the continued national recession hurt sales in 2011 (as it did for most companies). When asked about the issues D.C. faced at that time, Kay Johnson said that: We need more business to utilize our capacity and make a prot. As we do so, the main issue will be training people. It takes up to three months to train people adequately. Also, custom labeling needs to be more effectively marketed. This is our best margin area. If we focused our business on low-margin, high-volume chocolate bars we could be vulnerable to customers dropping us for another supplier. Costing Issue It is now 2012 and D.C. is starting to get bigger orders, such as the one for 200,000 bars. D.C. bars are also now being sold in some REI1 outlets around the country. As is common with small companies, Salmon River Foods has an inadequate costing system. For example, it is unable to compute actual costs per order or per bar. For pricing purposes, Kay estimates the costs of each type of bar using his experience and knowledge of ingredient prices and what he pays out each month in expenses. Each order is different, and typically ranges from 150 bars to 1 REI is a national retail chain of outdoor clothing and equipment products (see: www.REI.com). Dream Chocolate Company: Choosing a Costing System 3 10,000 bars. It is difcult for the company to estimate an accurate cost for an order for pricing purposes, so he really never knows whether orders are protable or not. Kay wondered how to accurately determine the cost for this new special orderthe biggest order in the company's history by far! Adding to the challenge are limited resources for more accounting work. D.C. employs an hourly wage Boise State University accounting graduate part-time to do its monthly bookkeeping (books are closed at the end of the year). A local CPA does its nancial statements, taxes, and provides occasional advice. However, Kay now needs a new type of costing system to provide accurate cost estimates, and is wondering what type of costing system makes sense for his small but growing business. PRODUCTION PROCESS Making high-quality chocolate bars is a challenging process. The bulk chocolate must be melted and avored just right before being tempered, which is a process that aligns the crystals in molten chocolate to produce the best texture balance of rm and creamy. Kay Johnson described the challenges in achieving the right formula: It's a high-end process. The chocolate is temperamental, and, much like wine, there are many different kinds, qualities, and layers of avor. We try to make ours less sugary and more pure, so that chocolate is the rst thing you taste. D.C. employs a full-time Master Chocolatier, who oversees the entire production process, lls in at any area when there is a need, and performs most of the product inspections. Exhibit 1 provides a ow chart of the 3,000 square foot factory and the seven production areas, each of which are discussed next. 1. Receiving Area As soon as the bulk chocolate is received in the Receiving Area, it is dated and placed in the Imported Chocolate Storage area. Organic chocolate, which comes from a U.S. supplier, has a separate shelf from the rest of the bulk chocolate. 2. Pouring Area After the Pouring Area is cleaned and cleared of all non-organic chocolate (if necessary), the bulk chocolate is brought to the melting pots to be melted. Any avors (e.g., mint or lavender oil) and ingredient additives (e.g., huckleberries or nuts) are added to the pots at the right time. This process consists of tempering and pouring the chocolate into molds, then moving the molds to the Cooling Tower. There are separate racks for organic and non-organic bars. 3. Inspection Area Bars are taken out of the molds on the Chocolate Breakdown Table, and the newly formed chocolate bars are placed on a rack in the Inspection Area. In the Inspection Area, the Master Chocolatier weighs the bars and visually inspects each one for aws. Flawed bars are sent back to the Chocolate Rework Storage area to be re-melted and used again. There is very little waste in the process and no by-products. 4. Foiling Area After the chocolate is inspected, it is sent to the Foiling Area to be manually foiled. After foiling, the chocolate bars are either sent immediately to the Labeling area to be completed as ''retail 4 Krumwiede and Walden EXHIBIT 1 Salmon River Foods/Dream Chocolate Floor Plan stock'' or put on the Foiled Product shelves to be held for future orders as ''bright stock.'' D.C. likes to keep bright stock on hand to be able to quickly ll future orders for the more common sizes and avors. Bright stock boxes are dated and used based on rst-in rst-out (FIFO). 5. Labeling Area In the Labeling Area, foiled chocolate bars are manually labeled and prepared for shipping. Some retail stock orders are labeled with standard, pre-designed D.C. labels describing the avor, type of chocolate, and possibly a theme (e.g., ''The Wine-Lovers Bar'' or ''Think Pink Dark Chocolate''). Other orders are for ''Custom Label Bars'' for advertising or special events (e.g., weddings, store openings). These labels include things like company logos, photos, paintings, and even resumes and personal business cards. D.C. requires a 150-bar minimum and charges an additional amount for the custom label design costs, which can vary signicantly depending on customer needs. VP Kathleen Wasson edits the many retail and custom labels produced for D.C. bars. All labels are printed on D.C.'s color laser printer. 6. Finished Product Storage Area All labeled bars are stored in the Finished Product Storage Area until shipped or picked up by customers. The company produces signicant varieties of both bright stock and retail stock. There are approximately 40-plus different avor and size variations of bright stock in storage. The retail stock has even more types of bars for different retail clients. 5 Dream Chocolate Company: Choosing a Costing System TABLE 1 Typical Prices and Costs of Chocolate 1.25 oz. Bar Price Per Bar \u0015 \u0015 Cost of Chocolatea \u0015 \u0015 3.0 oz. Bar 3.25 oz. Bar $1.40 $1.50 $0.18 $0.33 $0.03 $0.03 $2.40 NA $0.44 NA $0.06 $0.08 NA $2.55 NA $0.83 $0.06 $0.08 Non-Organic Organic Non-Organic Organic Cost of Foil Cost of Label a Does not include additional avors or ''stir-in'' ingredients. 7. Shipping Area The bars are invoiced, packed, and shipped out to the customer FOB shipping point. If deemed necessary, the bars are packed in insulated material with a cold pack to prevent melting. PRODUCT INFORMATION D.C. sells many types of bars, with varying sizes, ingredients, and avors. Although there are other sizes available, D.C. typically sells bars in three standard sizes: 1.25 oz. (both organic and non-organic), 3.0 oz. (non-organic only), and 3.25 oz. (organic only). This section describes the ingredients, labor, and overhead required to make its bars. Materials Table 1 provides typical prices and costs of chocolate for the standard-sized bars. The bulk chocolate is generally from German suppliers, but D.C. also has a U.S. supplier of high-quality chocolate. Chocolate prices can vary, due largely to unstable conditions in major cocoa beanproducing nations such as the Ivory Coast. Standard chocolate bars, with no additional avors or special ingredients, comprise about half (47 percent) of total sales. Besides chocolate and other ingredients, the product cost includes the foil and label. Table 1 provides the typical costs for these items. Bars can have one or more types of special avors and ingredient additives, such as the recent order from the wellness company. The additional costs for these additives are handled in different ways. Flavor additives are a relatively small part of the overall weight of the bar, and primarily affect the taste of the chocolate itself. Bars with higher-cost avor additives, such as coffee and Kava, comprise about 13 percent of sales. These ingredients are added to the pot and listed as an ingredient with a direct cost (e.g., $8 for two pounds of coffee used in a batch). Less expensive additives, such as avoring oils (e.g., mint or lavender), are not included in direct costs as a little goes a long way. These costs usually show up in overhead. Sixteen ounces of oil cost about $22, and D.C. uses only two ounces for a batch of 1,200 1.25-oz. bars. About 16 percent of product sales have these avoring oils. ''Stir-in'' ingredients are a relatively larger part of the weight of the bar, are clearly noticeable in the nal bar, and affect the overall taste of the bar rather than the chocolate itself. Bars with stir-in ingredients, such as huckleberries and all nuts, comprise about 24 percent of sales and add additional direct materials and direct labor costs. Kay estimates $12 per pound average for nuts, Krumwiede and Walden 6 TABLE 2 Average Labor Rates and Capacity Volumes by Labor Area Area Labor Rate/Houra Pouring Inspecting Foiling Labeling a $15.40 $11.00 $9.90 $9.90 1.25 oz. Bar 480 240 175 175 bars/hour bars/hour bars/hour bars/hour 3.0 oz. Bar 200 480 175 175 bars/hour bars/hour bars/hour bars/hour 3.25 oz. Bar 184 480 175 175 bars/hour bars/hour bars/hour bars/hour Includes payroll taxes and benets. ginger, and huckleberries, and these ingredients become about 5 percent of the nished weight of the bar. In addition to the direct materials cost for these ingredients, there is additional labor required for stirring to achieve equal distribution throughout the bar. Direct Labor Four of the seven production areas have labor costs that should be included in product cost. Direct labor comes from pouring, inspecting, foiling, and labeling. Table 2 provides the average labor rates (including benets) and estimated average number of bars that can be processed in each of the four labor areas. Notice that larger bars can be inspected twice as fast as the smaller bars. The reason is that larger bars have fewer defects, so less time is needed. Because each area might be working on multiple customer jobs at a time, it is difcult to track labor hours for each customer order. The extra labor cost for ''stir in'' ingredients is handled in one of two ways. If performed by the Master Chocolatier, whose salary is included in plant overhead cost, Kay considers it as no additional direct cost. If the Master Chocolatier is busy and other workers will be required, Kay adds $12.50/hour of labor to each stir-in batch when estimating the cost of a job. Overhead Costs Overhead costs include administrative costs, supplies, three salaried employees (including Kay, Kathleen, and the Master Chocolatier), an hourly wage customer service person, and lease payments for the building. Table 3 provides a breakdown of budgeted overhead costs per month of $19,800, on average. Note that each production area incurs costs for supplies each month. Capacity and Output Currently, the factory can pour up to about 300 pounds of 1.25-oz. chocolate bars per eighthour day. Different bar sizes can be produced in the same batch. However, as is usually the case, total factory output is constrained by bottleneck processes, number of qualied workers, and customer demand. Current budgeted production is 25,000 1.25-oz. bars and 1,000 3.0/3.25-oz. bars per month, with an estimated average order size of 200 bars. Typically, two-thirds of production is for organic bars. Kay tries to batch all the non-organic batches together and only switch from organic to non-organic once a month (there is no difference in setup time between the two types). There are typically two days of production in work-in-process between the pouring and foiling areas because that is how long it takes to make and foil the bars. Kay is optimistic that D.C. can produce the additional 20,000 to 25,000 bars per month needed for the big special order, but he will need additional equipment and trained workers. He will also Dream Chocolate Company: Choosing a Costing System 7 TABLE 3 Budgeted Monthly Overhead Cost Breakdown Cost Item Amount Admin. Costs Production Area Supplies Salaries Customer Service Lease Payments $1,000 3,800 10,000 3,000 2,000 Total Budgeted Overhead Costs $19,800 need to add an extra shift, but he must train additional workers rst. Training can take up to two months to be able to meet D.C.'s high standard of quality. Kay's Cost Estimates Table 4 shows how Kay estimates the cost of standard types of bars. When Kay estimates costs to price a typical order, he adds materials (including ingredients, foil, and label), direct labor, and overhead costs per bar to get the total estimated cost per bar. For overhead, he allocates $0.69 per bar based on producing at the bottleneck rate and assuming an average of 20.5 work days per month, one eight-hour shift per day, and one worker per labor area. Markup percentages vary and are affected by the size of the order and demand. When customers want a signicant discount from the normal price, he will usually decline unless there is a good chance of future business. He accepted the big order because of the high volume and prospect for more large orders. ACTION ITEMS Now put yourself in Kay Johnson's shoes and think about what type of costing approach will help you determine more accurate products costs for pricing different orders, like the recent big order. In Part A, you will analyze D.C.'s situation, identify its information needs, evaluate the pros and cons of different costing approaches, recommend an approach, and suggest ways to implement it. In Part B, you will calculate product costs based on your recommended approach. Part A: Choosing a Costing System A1: What Information Does D.C. Need? Before recommending a cost system, it is helpful to understand the cost information needs of the company. Based on case information, briey summarize D.C.'s competitive environment and its apparent strategy in response to that environment. Considering the company's strategy and products, what types of cost information should D.C.'s product costing system be able to provide? A2: Which Costing Approach(es) Do You Recommend? a: Discuss the pros and cons of the different costing approaches available to D.C., including job order costing, process costing, operation costing, and activity-based costing. 8 Krumwiede and Walden TABLE 4 How Kay Estimates Cost and Protability Per Bar Panel A: Compute Estimated Materials Costs Per Bar Material 1.25 oz. 3.0 oz. 3.25 oz. Non-Organic Chocolate Organic Chocolate $0.18 0.33 $0.44 NA NA $0.83 0.03 0.03 0.06 0.08 $0.06 $0.08 $0.24 $0.39 $0.58 NA NA $0.97 Foil Label Total Non-Organic Total Organic There would be additional costs for certain avor additives. Panel B: Compute Estimated Labor Costs Per Bar (Labor Rate 4 Bars Per Hour from Table 2) Labor Area 1.25 oz. 3.0 oz. 3.25 oz. Pouring Area Inspection Area Foiling Area Labeling Area $0.03 0.05 0.06 0.06 $0.08 0.02 0.06 0.06 $0.08 0.02 0.06 0.06 Total Labor Cost Per Bar $0.20 $0.22 $0.22 Panel C: Compute Estimated Overhead Cost Per Bar Total Overhead Costs Bottleneck Bars/Hour Hours/Day Avg. Work Days Per Month $19,800 175.0 3 8.0 3 20.5 4 28,700 Capacity Volume Per Month Overhead Cost Per Bar $0.69 Panel D: Compute Estimated Protability Per Bar 1.25 oz. Organic 1.25 oz. Non-Organic 3.0 oz. Non-Organic 3.25 oz. Organic $1.50 $1.40 $2.40 $2.55 0.39 0.20 0.24 0.20 0.58 0.22 0.97 0.22 0.69 0.69 0.69 0.69 Total Cost Per Bar $1.28 $1.13 $1.49 $1.88 Prot Per Bar $0.22 $0.27 $0.91 $0.67 Prot Percentage 14.7% 19.3% 37.9% 26.3% Price Per Bar Cost Per Bar Total Materials Costa Total Labor Costa Overhead Cost Per Bar a Additional costs required for certain avor additives. Dream Chocolate Company: Choosing a Costing System 9 b: Based on your analysis of costing approaches, which approach do you recommend D.C. use for direct costs? What about indirect costs? Provide support for your recommendation. Keep in mind it is a small company with limited staff and they do not currently track actual cost information during production. The approach should also be exible enough to handle high-volume or low-volume months. c: Discuss how you would handle different types of special ingredients, stir-ins, or labeling design costs for the new special order from the wellness company. You do not need to state how you would handle each specic ingredient. A3: Summary and Implementation Summarize your recommended costing approach and discuss how it will help Kay determine more accurate products costs for pricing different types of orders. What specic steps would you take to implement the new product costing approach? Hint: think about what new information would need to be collected and how you would collect it. Part B: Calculate Product Costs B1: Compute New Standard Product Costs a: D.C. does not currently track actual cost information, but Kay has estimated some additional production data provided in Table 5. Using the approach(es) you recommended in Part A and the estimated data provided in Tables 1-5 and the Case, use Excel to compute estimated total cost, prot margin, and margin percentage for each of the four jobs identied in Table 5, Panel A. b: Compare your costs and protability per bar to Kay's estimates in Table 4. What is the potential nancial impact of using your method instead of Kay's? B2: Special Order a: Starting with your standard bar costs from part B1, compute the estimated cost per bar for the new special order from the wellness products supplier for 200,000 1.25-oz. organic chocolate bars. The bars will have special stir-in ingredients that Kay estimates will cost about $10 per pound, and these ingredients will become about 7 percent of the nished weight of the bar. The additional labor required for stirring in these ingredients is estimated to be 10.5 hours at $12.50/hour for each batch of 10,000 bars. b: Compare your estimated cost per bar for the special order with the price, which is at a 20 percent discount off the normal price for these types of bars of $1.75. Will Kay make a prot on this order? REQUIRED FOR ACC 350 - Spring 2014 (Makridis) Report all requested recommendations and findings in a well written, professionally formatted memorandum from your consulting firm ("Group N Consulting - Consultant Name 1, . . .Consultant Name 5") to your client, Kay Johnson at Salmon River Foods. Display relevant tables in the memorandum and submit it with an Excel workbook containing supporting calculations and timesheets for each team member via Blackboard. You must complete this project in under 15 hours total. Budget your time carefully. Your deliverables will be assessed holistically based on how well they conform to a typical consulting firm's expectations for an entry level associate on a relatively simple engagement. The less time the engagement manager must spend to make your deliverables presentable, the higher your evaluation will be. As you draft the deliverables, it is critical that you ask, "Am I delivering insights and solutions that the client will find valuable? Am I delivering them in a way that is sensitive to the client's resource constraints? Am I being efficient?" Be brutally honest with yourself in answering these questions. Clients (and engagement managers) can be very unforgiving! To receive credit for this assignment, you must also complete an evaluation for each of your individual group members within 48 hours of the Project I deadline. Your personal grade for the project will be driven by the quality and professionalism of the group deliverable AND the team's feedback on your individual contribution. 10 Krumwiede and Walden TABLE 5 Additional Estimated Data for Part B Panel A: Job-Specic Information Job 1 1.25/Org. Job 3 3.0/Non-Org. Job 4 3.25/Org. Other Jobs Total Month 10,000 $3,135 274 347 5,000 $945 133 163 200 $84 11 16 300 $274 18 21 10,500 $3,162 374 283 26,000 $7,600 810 830 $3,756 No. of Bars Cost of Chocolate Cost of Foil Cost of Label Job 2 1.25/Non-Org. $1,241 $111 $313 $3,819 $9,240 Panel B: Beginning Work-In-Process (BWIP), Direct Labor (DL), and Overhead (OH) Costs Added (Per Month) BWIPMaterials BWIPCC DL Added OH Added Total Added $1,550 $0 $0 $757 $0 $0 $2,348 $1,430 $1,016 $1,800 400 1,400 $4,148 1,830 2,416 Total Area Costs Added Other Overhead Costs Supplies Admin. Costs Salaries Customer Service Lease Payments $3,600a $8,394 $200 1,000 10,000 3,000 2,000 $200 1,000 10,000 3,000 2,000 Total Other Overhead $16,200b $16,200 $19,800 $24,594 Pouring/Inspection Foiling Labeling Total Costs Added a b $1,550 $757 $4,794 Represents supplies costs traced directly to labor areas. Represents other overhead costs that cannot be directly traced to labor areas. Panel C: Expected Monthly Production Volume (in Bars) Type of Production Beginning WIP in Pouring/Inspection Bars started in Pouring/Inspection Bars completed in Pouring/Inspection Bars Foiled Bars Labeled (assume 25 percent bright stock) Total Bars 1.25 oz. 3.0/3.25 oz. EWIP % Comp. 3,000 26,000 27,000 26,600 19,950 2,500 25,000 26,500 26,125 19,594 500 1,000 500 475 356 50% 0% 0% (continued on next page) 11 Dream Chocolate Company: Choosing a Costing System TABLE 5 (continued) Panel D: Activity-Based Information Actual Amount Level Driver Actual Volume $3,600 2,000 2,000 6,300 4,000 1,900 Activity Unit-level Batch Batch Customer Customer Facility Trace to areas Setups Purchase orders # Orders Design hours Square feet 100.0 80.0 500.0 40 3,000 Area Supplies Setting Up Melting Pots Purchasing Filling Orders Designing Labels Facility-Related Costs Total Overhead Costs $19,800 Panel E: Area-Specic Activity Pouring Purchase Orders Square Feet Inspection Foiling Labeling Total 60 750 0 750 4 750 16 750 80 3,000 Panel F: Job-Specic Activity Volumes Activity Setups Design Hours Labor Hours Pouring Inspection Foiling Labeling Job 1 1.25/Org. Job 2 1.25/Non-Org. Job 3 3.0/Non-Org. Job 4 3.25/Org. 10 5.0 5 4.0 1 2.0 1 2.0 22.00 45.00 58.00 58.00 11.00 23.00 29.00 29.00 1.00 0.50 1.20 1.20 1.75 0.75 1.75 1.75