Problem 5-56

World Gourmet Coffee Company (WGCC) is a distributor and processor of different blends of coffee. The company buys coffee beans from around the world and roasts, blends, and packages them for resale. WGCC currently has 15 different coffees that it offers to gourmet shops in one-pound bags. The major cost is raw materials; however, there is a substantial amount of manufacturing overhead in the predominantly automated roasting and packing process. The company uses relatively little direct labor.

Some of the coffees are very popular and sell in large volumes, while a few of the newer blends have very low volumes. WGCC prices its coffee at full product cost, including allocated overhead, plus a markup of 30 percent. If prices for certain coffees are significantly higher than market, adjustments are made. The company competes primarily on the quality of its products, but customers are priceconscious as well.

Data for the 20x1 budget include manufacturing overhead of $3,000,000, which has been allocated on the basis of each products direct-labor cost. The budgeted direct-labor cost for 20x1 totals $600,000. Based on the sales budget and raw-material budget, purchases and use of raw materials (mostly coffee beans) will total $6,000,000.

The expected prime costs for one-pound bags of two of the companys products are as follows:

Kona Malaysian

Direct material $3.20 $4.20

Direct labor.. .30 .30

WGCCs controller believes the traditional product-costing system may be providing misleading cost information. She has developed an analysis of the 20x1 budgeted manufacturing-overhead costs shown in the following chart.

Activity Cost Driver Budgeted Activity Budgeted Cost

Purchasing Purchase orders 1,158 $ 579,000

Material handling Setups 1,800 720.000

Quality control Batches 720 144.000

Roasting Roasting hours 96,100 961.000

Blending Blending hours 33,600 336.000

Packaging Packaging hours 26,000 260.000

Total manufacturing overhead cost $3,000,000

Data regarding the 20x1 production of Kona and Malaysian coffee are shown in the following table. There will be no raw-material inventory for either of these coffees at the beginning of the year.

Kona Malaysian

Budgeted sales 2,000lb. 100,000lb.

Batch size 500lb. 100,000lb.

Setups 3 per batch 3 per batch

Purchase order size 500lb. 500lb.

Roasting time 1 hr. per 100lb. 1 hr. per 100lb.

Blending time .5hr per 100lb .5hr per 100lb.

Packaging time .1hr per 100lb. .1hr per 100lb.

Required:

1. Using WGCCs current product-costing system: a. Determine the companys predetermined overhead rate using direct-labor cost as the single cost driver. b. Determine the full product costs and selling prices of one pound of Kona coffee and one pound of Malaysian coffee.

2. Develop a new product cost, using an activity-based costing approach, for one pound of Kona coffee and one pound of Malaysian coffee.

3. What are the implications of the activity-based costing system with respect to a. The use of direct labor as a basis for applying overhead to products? b. The use of the existing product-costing system as the basis for pricing?