Mother Earth Mulch: Analyzing the Impact of Cost Allocation on Cost Center Performance$$The Mulch Company produces a variety of mulch products for ornamental gardens, residential and commerciallandscapes, and children$$s playgrounds. The Mulch Company operates two divisions$$Perma Mulch and MotherEarth Mulch $($MEM$).$ Perma Mulch manufactures mulches that degrade very slowly, if at all, from relativelystable materials like gravel, glass, and rubber. The focus of this case, however, is on MEM.MEM produces packaged landscape mulch in two$-$cubic$-$foot bags at five manufacturing$/$packaging plants inthe United States. MEM produces mulch from cypress, cedar, pine, and several hardwoods trees. The companyalso produces mulch from each type of tree in two different qualities$$All Bark Mulch $($AB$)$ and Whole WoodMulch $($WW$).$ The company markets AB mulch as a premium mulch because it decays slower and holds auniform color for a longer time. The cost analysis in this case focuses on AB and WW as if they were the onlytwo products because processing costs do not differ by the type of tree. Instead, cost differences occur becauseof the processing requirements of AB vs$.$ WW$.$In addition to the five manufacturing$/$packaging plants, MEM operates $20$ collection facilities around the U$.$S$.$where it collects raw materials and performs some preliminary processing. These facilities collect material froma variety of trees, but the mix of trees varies somewhat by region. Nevertheless, the steps in processing are thesame at all collection facilities. Because the collected material is simply sent on to manufacturing$/$packagingplants after sorting and some preliminary processing, MEM operates its $20$ collection facilities as cost centersand its five manufacturing facilities as profit centers.Each collection facility obtains raw material of two basic types including bark and whole wood material$\mathrm{.}1.$ Bark Material$$Regional paper mills and sawmills deliver bark to collection facilities. Before the facilitycan process logs and pulpwood into paper products or dimensional lumber, it must remove the bark from thelogs. Although the bark has little sales value relative to the main products of these industries, companies sellit as a byproduct to MEM, which also saves the mills the cost of landfill disposal. Due to proximity and otherfactors, landfill disposal is somewhat less costly than delivering bark to MEM, so MEM must pay enough forthe bark to motivate supply$\mathrm{.}2.$ Whole Wood Material$$In the locations of the collection facilities, MEM receives favorable tax treatmentfrom state and local governments in exchange for recycling landscape waste material area residents bring in$.$WW material also includes tree trimming debris brought in by commercial tree service companies, utilitycompanies, departments of transportation, parks departments, and so on$.$ Some of this debris is in the form ofintact limbs$,$ but some goes through a chipping machine before it reaches the collection facilities. MEM paysa nominal amount for the raw material.AB AND WW PROCESSINGProcess includes sorting, grinding, moving, and shipping:$1.$ Sorting$$In a direct$-$labor intensive process, facilities must unload and sort raw material by type: cypress,cedar, pine, hardwood, organic debris, and inorganic debris. The sorted usable material goes into temporaryfive$-$cubic$-$yard holding bins that operators $($forklift drivers$)$ move to the grinding area.a$.$ The facilities sort AB and WW material by type of tree that it came from, but AB requires significantly lesssorting than WW because of the nature of the raw material.b$.$ WW material requires more sorting than bark because it can include significant amounts of unusablematerial. While facilities haul inorganic debris to nearby landfills, organic debris goes into a compostthen resold to the community at nominal prices sufficient to cover the cost of the composting operation aswell as the cost of disposing the inorganic debris. This feature of operations is one reason MEM gets suchfavorable tax treatment.c$.$ Usable AB material is sorted in $1/6$th of the time to obtain the same quantity of usable WW material$\mathrm{.}2.$ Grinding$$Machine operators grind and screen sorted raw material up to three times to obtain relativelyuniform particle sizes and then load it back into the temporary holding bins.a$.$ Bark, on average, requires a little less grinding than WW$.$ It is usually ground and sifted once or twicedepending on how the mills that supply it mechanically removed the bark.b$.$ WW sometimes requires grinding a third time because the long wood fibers in whole limbs are moredifficult to reduce to acceptable sizes. Nevertheless, there is no material difference in the average timemachine operators need to process AB and WW after sorting it$\mathrm{.}3.$ Moving$$The holding bins of ground raw material go into holding areas specific to each type of material$\mathrm{.}4.$ Shipping$$As needed by manufacturing and packaging plants, machine operators load raw material intoreusable, stackable shipping containers similar to the large commercial dumpsters on construction sites. Eachdumpster holds $20$ cubic yards of ground raw material.The higher cost that collection facilities must pay for AB material in order to motivate supply is thought to beoffset by the increased direct labor cost required to process WW$.$ Therefore, the collection facilities$$ total perunit cost targets are the same for both products. Also, in accordance with contractual agreements, the collectionfacilities are open $365$ days per year.Although the supply of bark material from paper mills is relatively constant, the supply from sawmills is bothseasonal and cyclical, moving in tandem with the market for new$-$home construction. From MEM$$s perspective,externalities drive volatility in the supply of bark, which means that the MEM price for bark has a limited impacton the quantity supplied. Nevertheless, a minor impact is possible because higher prices might encourage agreater number of smaller mills to enter the bark market rather than choosing alternative means of disposal.MEM has significantly more control over the supply of WW material it receives, and when the supply of ABmaterial increases, MEM decreases the supply of WW by offering a lower price for that material. To some extent,the materials represent alternative uses of capacity because MEM marketing managers have some flexibility inthe mix of AB$-$based vs$.$ WW$-$based products that they can sell to customers.$$Table $1$: Year $5$ Operating Results for Collection FacilitiesMEM traces direct labor to AB or WW for costing purposes but allocates the salaries of facility managers and thewages of machine operators as part of total collection facility overhead. Total collection facility overhead also includessome $$Other Indirect Labor,$$ which is a fixed cost with respect to production levels. MEM has one additional categoryof collection facility overhead called $$Other Facility Overhead$$ that includes repairs, utilities, and insurance, but thelargest component of this category is depreciation on machinery and buildings computed on a straight$-$line basis.In addition to facility overhead, MEM allocates each collection facility a share of corporate$-$level overhead thatincludes executive salaries as well as centralized support services such as human resources and accounting.Corporate overhead is allocated to divisions based on direct labor cost. The MEM division further allocatesits share of corporate$-$level overhead to collection facilities and manufacturing plants based on their respectivedirect labor costs. The collection facilities and manufacturing plants further allocate these corporate$-$level coststo product lines based on their respective direct labor costs. At collection facilities in Year $5,$ corporate$-$leveloverhead was allocated to products at $82\%$ of their direct labor cost.Data from the accounting information system regarding collection facility operations in Year $6$ include:$$ The facilities processed $180,000$ bins of material$50\%$ of which were WW$.$ The price for a usable cubic yard of WW material decreased by $1/3$rd$,$ but the premium for each cubic yardof AB material in excess of the price paid for WW material increased from $100\%$ of WW prices in Year $5$ to$250\%$ of WW prices in Year $6.$ As of January $1,$ Year $6,$ across the board raises resulted in an increase of $5\%$ in the average wage rates andsalaries of all categories at all collection facilities.$$ Total direct labor cost at collection facilities was $$4,281,553$ USD$1.$ Machine operator cost was $$2\mathrm{.}8$ million.$$ The $$Other Facility Overhead$$ cost pool totaled $$1\mathrm{.}155$ million.$$ Corporate$-$level overhead was allocated to products at $89\%$ of their direct labor cost.In February of Year $7,$ in advance of performance evaluations for division managers, The Mulch Company$$schief operating officer $($COO$)$ was reviewing cost data for MEM$$s collection facilities for Year $5$ and Year $6$ anddid not like what he saw. As the company$$s controller, you will advise the COO on the best interpretation of thedata and the implications for performance at the collection facilities.$$