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Johnson Beverage Inc. (JBI) Due March 20, 2017 by 5pm via email or BlackBoard 1. Please describe the problem faced by JBI and how their accounting data influenced Jack Johnson's initial reaction to the problem (15 points). 2. In Exhibit 1 of the case, Jim Thomas prepared an analysis depicting his view of customer profitability. Do you think his analysis is helpful? Why or why not? (5 points) 3. Please prepare your own analysis showing the profitability of JBI's four key customers using the Activity Based Costing approach that we discussed in class and as presented in chapter 7 of our text (45 points) 4. Based on the analysis you created, what would you recommend that JBI do in response to potential price reductions requested by Saver Superstore and Oscar's OddLots? What specific recommendations would you make to change the structure of the pricing model used by JBI in order to influence customer behavior and/or improve profitability? (PLEASE MAKE AT LEAST 3 RECOMMENDATIONS AS TO HOW JBI CAN IMPROVE ITS PRICING MODEL FOR ALL CUSTOMERS) (35 points) You may perform your calculations on a spreadsheet or on paper - it's your choice. Whichever you choose, please make sure you show your work so that you have the opportunity to earn partial credit where applicable. Here is how I would suggest you approach Question #3 of the case: a. First, it might be helpful if you re-read slides #9 - #36 of the Chapter 7 Power Point slide deck posted on BlackBoard. Those slides provide a similar analysis for Baxter Battery and walk through a 5-step process. The first two steps have already been done in the JBI case so you can skip those. (Step #1 of the PP slides result in the data in Table #2 of JBI and Step #2 of the PP slides results in the data in Table #1 of JBI). b. Step #3 of the PP slides illustrates how to calculate Activity Rates for each Activity Cost Pool. There are 5 activity cost pools in JBI as listed in Table #1. For example, the activity rate for the first pool ("Product Handling") is calculated as follows: = Cost of Product Handling (Table #1) divided by Number of Cases Sold company-wide by JBI (The Cost Driver is identified in Table 2 and the corresponding data is in Exhibit #2) = $672,000/800,000 cases = $0.84 per case Do a similar calculation for the other four Activity Cost Pools. For "Delivering the Product", keep in mind that the "number of miles traveled" for the company is the total deliveries (4,480) multiplied by the average miles per trip (10). c. Step #4 of the PP Slides is Assigning Overhead to Products or Customers - see slides #28 and #29 for the latter. You need to assign the cost of the 5 Activity Pools to each customer using the rates you calculate in "b" above. For example, the cost of the first pool ("Product Handling") is assigned as follows: = Quantity of Cost Driver associated with each customer x Activity Rate for that Pool. = 80,000 cases sold to Saver Superstore x $0.84 per case = $67,200 So, $67,200 is the cost of Product Handling that we are assigning to Saver Superstore based on the level of activity JBI spends on this particular customer. You will then do additional calculations for each of the other three customers. You need to assign each of the five Activity Pool costs to each of the four customers so there are a total of 20 separate calculations. You may find it easier to do this on a spreadsheet but some students prefer to do the calculations by hand. d. The fifth and final step of the calculations is shown on slides #35 - #36. Here you will be taking the data already given in the first three lines of Exhibit #1 (Revenues, Cost of Goods and Gross Margin) and then deduct the customer service costs as you assigned them in "c" above using the ABC method. (The customer service costs as assigned in Exhibit #1 of the case were done in a simplified fashion by Jim Thomas at JBI - we are looking for a better method) Scanned by CamScanner Scanned by CamScanner Scanned by CamScanner Scanned by CamScanner Scanned by CamScanner Scanned by CamScanner Scanned by CamScanner Activity-Based Costing: A Tool to Aid Decision Making Chapter 7 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright 2015 by McGraw-Hill Education. All rights reserved. 2 Activity-Based Costing (ABC) ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity, and therefore, affect \"fixed\" as well as variable costs. ABC is a good supplement to our traditional cost system I agree! 3 Learning Objective 1 Understand activitybased costing and how it differs from a traditional costing system. 4 How Costs are Treated Under Activity-Based Costing ABC differs from traditional cost accounting in three ways. Each ABC cost pool has its own unique measure of activity. Traditional cost systems usually rely on volume measures such as direct labor hours and/or machine hours to allocate all overhead costs to products. ABC uses more cost pools. 5 How Costs are Treated Under Activity-Based Costing Activity An event that causes the consumption of overhead resources. Activity Cost Pool A \"cost bucket\" in which costs related to a single activity measure are accumulated. $$ $ $ $ $ 6 How Costs are Treated Under Activity-Based Costing Activity Measure An allocation base in an activity-based costing system. The term cost driver is also used to refer to an activity measure. 7 How Costs are Treated Under Activity-Based Costing Two common types of activity measures: Transaction driver Duration driver Simple count of the number of times an activity occurs. A measure of the amount of time needed for an activity. 8 Characteristics of Successful ABC Implementations Strong top management support Link to evaluations and rewards Cross-functional involvement 9 Baxter Battery - An ABC Example Baxter Battery Company Income Statement Year Ended December 31, 2014 Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Gross margin Selling and administrative expenses Shipping expenses Marketing expenses General administrative expenses Net operating income loss $ 50,000,000 $ 15,000,000 12,000,000 14,000,000 3,000,000 2,000,000 6,000,000 41,000,000 9,000,000 11,000,000 $ (2,000,000) Manufacturing overhead is allocated to products using a single plantwide overhead rate based on machine hours. 10 Define Activities, Activity Cost Pools, and Activity Measures At Baxter Battery, the ABC team selected the following activity cost pools and activity measures: Activity Cost Pools at Baxter Battery Activity Cost Pool Customer orders Design changes Order size Customer relations Other Activity Measure Number of customer orders Number of design changes Machine-hours Number of active customers Not applicable 11 Define Activities, Activity Cost Pools, and Activity Measures Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. Design Changes - assigned all costs of resources consumed by customer requested design changes. Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. Customer Relations - assigned all costs associated with maintaining relations with customers. Other - assigned all organization-sustaining costs and unused capacity costs 12 Learning Objective 2 Assign costs to cost pools using a first-stage allocation. 13 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6,000,000 Factory equipment depreciation 3,500,000 Factory utilities 2,500,000 Factory building lease 2,000,000 $ General Administrative Department Administrative wages and salaries 4,000,000 Office equipment depreciation 900,000 Administrative building lease 1,100,000 Marketing Department Marketing wages and salaries 1,500,000 Selling expenses 500,000 Total overhead costs $ 14,000,000 6,000,000 2,000,000 22,000,000 14 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6,000,000 Factory equipment depreciation 3,500,000 Factory utilities 2,500,000 Factory building lease 2,000,000 $ 14,000,000 General Administrative Department Administrative wages and salaries 4,000,000 Office equipment depreciation 900,000 Administrative building lease 1,100,000 6,000,000 Marketing Department Direct materials, labor, and shipping Marketing wagesdirect and salaries 1,500,000 are excluded Selling expenses 2,000,000 because Baxter Battery's existing cost500,000 system can directly Total overhead 22,000,000 trace thesecosts costs to products or customer$ orders. 15 Assign Overhead Costs to Activity Cost Pools At Baxter Battery the following distribution of resource consumption across activity cost pools is determined. Activity Cost Pools Customer Design Orders Changes Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Order Size Customer Relations Other Total 30% 20% 0% 0% 30% 10% 10% 0% 20% 60% 60% 0% 10% 0% 0% 0% 10% 10% 30% 100% 100% 100% 100% 100% 30% 30% 0% 10% 10% 0% 10% 0% 0% 30% 20% 0% 20% 40% 100% 100% 100% 100% 30% 20% 10% 0% 0% 0% 50% 70% 10% 10% 100% 100% 16 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total Production Department Indirect factory wages $ 6,000,000 equipment depreciation 3,500,000 Activity Factory Cost Pools Factory utilities 2,500,000 Customer Design Customer Factory building lease Relations 2,000,000 Orders changes Order Size Other $ General Administrative Department Administrative wages and salaries 4,000,000 $ 1,800,000 Office equipment depreciation 900,000 Administrative building lease 1,100,000 Marketing Department Marketing wages and salaries 1,500,000 Selling expenses 500,000 Total overhead costs $ 14,000,000 Total 6,000,000 2,000,000 22,000,000 Indirect factory wages $6,000,000 Percent consumed by customer orders 30% $1,800,000 17 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total Production Department Indirect factory wages $ 6,000,000 equipment depreciation 3,500,000 Activity Factory Cost Pools Factory utilities 2,500,000 Customer Design Customer Factory building lease Relations 2,000,000 Orders changes Order Size Other $ General Administrative Department Administrative wages and salaries 4,000,000 $ 1,800,000 Office equipment depreciation 900,000 700,000 Administrative building lease 1,100,000 Marketing Department Marketing wages and salaries 1,500,000 Selling expenses 500,000 Total overhead costs $ 14,000,000 Total 6,000,000 2,000,000 22,000,000 Factory equipment depreciation $3,500,000 Percent consumed by customer orders 20% $ 700,000 18 Assign Overhead Costs to Activity Cost Pools Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ Activity Cost Pools Design changes Order Size 1,800,000 $ 700,000 1,200,000 270,000 - $ 450,000 100,000 4,520,000 $ 1,800,000 $ 350,000 250,000 400,000 90,000 150,000 3,040,000 $ 1,200,000 $ 2,100,000 1,500,000 400,000 5,200,000 $ Customer Relations Other Total 600,000 $ 350,000 750,000 2,000,000 6,000,000 3,500,000 2,500,000 2,000,000 1,200,000 180,000 - 800,000 360,000 1,100,000 4,000,000 900,000 1,100,000 750,000 350,000 3,080,000 $ 150,000 50,000 6,160,000 $ 600,000 $ - 1,500,000 500,000 22,000,000 19 Learning Objective 3 Compute activity rates for cost pools. 20 Calculate Activity Rates The ABC team determines that Baxter Battery will have these total activities for each activity cost pool: 10,000 customer orders, 4,000 design changes, 800,000 machine-hours, 2,000 customers served. Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels. 21 Calculate Activity Rates Computation of Activity Rates Activity Cost Pools Customer orders Design changes Order size Customer relations Other Total (a) Total Cost $ 4,520,000 3,040,000 5,200,000 3,080,000 6,160,000 $ 22,000,000 (b) Total Activity 10,000 orders 4,000 changes 800,000 MHs 2,000 customers Not applicable (a) (b) Activity Rate $452 per order $760 per change $6.50 per MH $1,540 per customer Not applicable 22 Activity-Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Traced Traced Traced Overhead Costs Cost Objects: Products, Customer Orders, Customers 23 Activity-Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs First-Stage Allocation Customer Orders Design Changes Order Size Customer Relations Cost Objects: Products, Customer Orders, Customers Other 24 Activity-Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs First-Stage Allocation Customer Orders Design Changes Order Size Customer Relations Other Second-Stage Allocations $/Order $/Change $/MH $/Customer Cost Objects: Products, Customer Orders, Customers Unallocated 25 Learning Objective 4 Assign costs to a cost object using a secondstage allocation. 26 Assigning Overhead to Products Baxter Battery Information SureStart 1. Requires no new design resources. 2. 800,000 batteries ordered with 4,000 separate orders. 3. Each SureStart requires 36 minutes of machine time for a total of 480,000 machine-hours. LongLife 1. Requires new design resources. 2. 400,000 batteries ordered with 6,000 separate orders. 3. 4,000 custom designs prepared. 4. Each LongLife requires 48 minutes of machine time for a total of 320,000 machine-hours. 27 Assigning Overhead to Products Overhead Cost for the SureStart Activity Cost Pools Customer orders Design changes Order size Total (a) Activity Rate $ 452.00 760.00 6.50 (b) Activity 4,000 480,000 $ $ (a) (b) ABC Cost 1,808,000 3,120,000 4,928,000 Overhead Cost for the LongLife Activity Cost Pools Customer orders Design changes Order size Total (a) Activity Rate $ 452.00 760.00 6.50 (b) Activity 6,000 4,000 320,000 $ $ (a) (b) ABC Cost 2,712,000 3,040,000 2,080,000 7,832,000 28 Assigning Overhead to Customers Let's take a look at how Baxter Battery's system works for just one of the 2,000 customers - Acme Auto Parts who placed a total of twelve orders. Note that the four orders for LongLifes required a design change. Orders 1. Eight orders for 60 SureStarts per order. 2. Four orders for 50 LongLifes per order. Machine-hours 1. The 480 SureStarts required 288 machine-hours. 2. The 200 LongLifes required 160 machine hours. 29 Assigning Overhead to Customers Overhead Cost for Acme Auto Parts Activity Cost Pools Customer orders Design changes Order size Customer relations Total (a) Activity Rate $ 452.00 760.00 6.50 1,540.00 (b) Activity 12 4 448 1 (a) (b) ABC Cost $ 5,424 3,040 2,912 1,540 $ 12,916 30 Learning Objective 5 Use activity-based costing to compute product and customer margins. 31 Prepare Management Reports Product Margin Calculations The first step in computing product margins is to gather each product's sales and direct cost data. Sales Direct costs Direct material Direct labor Shipping SureStarts $ 31,300,000 LongLifes $ 18,700,000 Total $ 50,000,000 9,000,000 7,000,000 2,000,000 6,000,000 5,000,000 1,000,000 15,000,000 12,000,000 3,000,000 32 Prepare Management Reports Product Margin Calculations The third step in computing product margins is to deduct each product's direct and indirect costs from sales. Sales Costs Direct material Direct labor Shipping Customer orders Design changes Order size Total cost Product margin SureStarts $ 31,300,000 $ 9,000,000 7,000,000 2,000,000 1,808,000 LongLifes $ 18,700,000 $ 6,000,000 5,000,000 1,000,000 2,712,000 3,040,000 2,080,000 3,120,000 22,928,000 $ 8,372,000 19,832,000 $ (1,132,000) 33 Prepare Management Reports Product Margin Calculations The product margins can be reconciled with the company's net operating income as follows: Sales Total costs Product margins Less costs not assigned to products: Customer relations Other Total Nett operating income loss SureStarts $ 31,300,000 22,928,000 $ 8,372,000 LongLifes $ 18,700,000 19,832,000 $ (1,132,000) Total $ 50,000,000 42,760,000 $ 7,240,000 3,080,000 6,160,000 9,240,000 $ (2,000,000) 34 Prepare Management Reports Customer Margin Analysis The first step in computing Acme Auto Parts' customer margin is to gather its sales and direct cost data. Sales Direct costs Direct material Direct labor Shipping Acme Auto Parts $ 29,200 7,500 6,700 1,700 35 Prepare Management Reports Customer Margin Analysis The second step is to incorporate Acme Auto Parts' previously computed activity-based cost assignments. Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Product design Order size Customer relations Acme Auto Parts $ 29,200 7,500 6,700 1,700 5,424 3,040 2,912 1,540 36 Prepare Management Reports Customer Margin Analysis The third step is to compute Acme Auto Parts' customer margin of $384 by deducting all its direct and indirect costs from its sales. Sales Direct costs Direct material Direct labor Shipping Customer orders Product design Order size Customer relations Customer margin Acme Auto Parts $ 29,200 $ 7,500 6,700 1,700 5,424 3,040 2,912 1,540 28,816 $ 384 37 Product Margins Computed Using the Traditional Cost System The first step in computing product margins is to gather each product's sales and direct cost data. Sales Direct costs Direct material Direct labor SureStarts $ 31,300,000 LongLifes $ 18,700,000 Total $ 50,000,000 9,000,000 7,000,000 6,000,000 5,000,000 15,000,000 12,000,000 38 Product Margins Computed Using the Traditional Cost System The second step in computing product margins is to compute the plantwide overhead rate. Manufacturing Overhead Costs at Baxter Battery Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Total manufacturing overhead Plantwide manufacturing overhead rate = $ 6,000,000 3,500,000 2,500,000 2,000,000 $ 14,000,000 $14,000,000 800,000 MH SureStarts (800,000 @ 0.60 hours) LongLifes (400,000 @ 0.80 hours) Total machine-hours = $17.50 per machine-hour Machine-hours 480,000 320,000 800,000 39 Product Margins Computed Using the Traditional Cost System The third step in computing product margins is allocate manufacturing overhead to each product. SureStarts LongLifes Total overhead allocated to products Machine Overhead Overhead Hours Rate Allocated 480,000 $ 17.50 $ 8,400,000 320,000 17.50 5,600,000 $ 14,000,000 480,000 hours $17.50 per hour = $8,400,000 40 Product Margins Computed Using the Traditional Cost System The fourth step is to actually compute the product margins. Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Product margin Selling and administrative Nett operating operating income loss SureStarts $ 31,300,000 $ 9,000,000 7,000,000 8,400,000 LongLifes $ 18,700,000 $ $ 24,400,000 6,900,000 Shipping expenses Marketing expenses General administrative expenses 6,000,000 5,000,000 5,600,000 Total $ $ 16,600,000 2,100,000 15,000,000 12,000,000 14,000,000 $ $ 3,000,000 2,000,000 6,000,000 $ 11,000,000 50,000,000 41,000,000 9,000,000 11,000,000 (2,000,000) 41 Differences Between ABC and Traditional Product Costs Product margins - traditional Product margins - ABC Change in reported margins The traditional cost system overcosts the SureStarts and reports a lower product margin for this product. SureStarts $ 6,900,000 8,372,000 $ 1,472,000 LongLifes $ 2,100,000 (1,132,000) $ (3,232,000) The traditional cost system undercosts the LongLifes and reports a higher product margin for this product. 42 Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another. Traditional costing allocates all manufacturing overhead to products. ABC costing only assigns manufacturing overhead costs consumed by products to those products. 43 Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another. Traditional costing allocates all manufacturing overhead costs using a volume-related allocation base. ABC costing also uses non-volume related allocation bases. 44 Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another. Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products. 45 Targeting Process Improvement Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements by focusing on activities to eliminate waste, decrease processing time, and reduce defects. ABC activity rates can also provide valuable clues concerning where there is waste and the opportunity for improvement. Benchmarking can be used to compare activity cost information with standards of performance achieved by other organizations. 46 Activity-Based Costing and External Reporting Most companies do not use ABC for external reporting because . . . 1. External reports are less detailed than internal reports. 2. It may be difficult to make changes to the company's accounting system. 3. ABC does not conform to GAAP. 4. Auditors may be suspect of the subjective allocation process based on interviews with employees. 47 ABC Limitations Substantial resources required to implement and maintain. Resistance to unfamiliar numbers and reports. Desire to fully allocate all costs to products. Potential misinterpretation of unfamiliar numbers. Does not conform to GAAP. Two costing systems may be needed. 48 End of Chapter 7