This case study analysis examines the use of activity based costing in Besto Company, a cheese manufacturer. It compares the conventional costing system with the activity based costing method and recommends the adoption of activity based costing for more accurate cost allocation and pricing decisions.
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Name:Student ID: Case Study Analysis – Besto Company Background of the Case: Besto Company is a manufacturer of cheese which currently manufactured a wide variety of chees includingCheddar, Edam, Gouda, Feta, Mascarpone, and Queso Blanco. While the company was producing the Cheddar, Edam, Gouda cheese range for over 20 years now, it has recently started with wide range of low-volume speciality lines of chees which includes Feta, Mascarpone, and Queso Blanco. The new lines are complex to produce but require very short runs and the company currently have figures that indicate these lines as the most profitable for the company. Conventional or Current Costing System: The company currently employs a system of costing that allocates the overhead of the company using a single plantwide rate. This current plantwide rate in use is computed using the total overheads and the estimated annual number of units produced by the company. This method is also known as the traditional or job costing method. Job costing or the traditional costing apportions the total cost of the company to the products manufactured on the basis of the single allocation factor be it the total machine hours, total labour hours, total number of products, total labour cost or any other such single factor. The current plantwide rate is total overheads divided by the estimated annual number of units produced by the company.The same is computed as below: Conventional Costing System - Plantwide Rate Total Cost$53,98,400 Annual Production5,12,000 Plantwide Rate (Total Overhead / Annual Units) $10.5438 Based on this conventional plantwide rate, the costs of the two given products for analysis is computed as below: Computation of Per unit Cost ParticularsCheddarMascarpone Estimated Annual units produced1,03,00012,500 Direct Material$25,750$12,500 Overhead Allocated (No. of Units * Plantwide rate) $10,86,006$1,31,797 Total Cost$11,11,756$1,44,297 Per unit Cost (Total Cost/Units) - Conventional$10.7938$11.5438 Page |1
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Name:Student ID: Using the current costing system the cost of the two variety of cheese comes out to be approximately the same. This is misguiding as we know that the efforts required to manufacture these two varieties are varied and thus their costs should also be different. The company currently uses this cost for their pricing decision andsets a selling price of $9 per unit of Cheddar and $12 per unit ofMascarpone. This pricing and cost makes them believe that the product is profitable and giving huge profit margins. But in reality, the overall profits of the company are declining and that is a matter of concern. We will now see the costs of the product using methods and ways of Activity based Costing. Activity Costing System: The activity based costing is a modern approach in costing wherein the product costs of the organization is computed on the basis of the costs of each activity that is being consumed by theproducttillitreachesathedeliverypointfortheconsumers.ABCstartswith identification of the underlying activities or resources of the organisation and then allocates the resource costs to the products and/or services based on the usage of these resources. This is a more robust approach of allocating overhead costs to the products of an organization. ABC Costing and Traditional Costing Methods: Both Conventional and ABC costing method allocates the cost of the company to the product sold. The major point of difference between the two is the allocation base that they use to allocate the costs to the company to the products. While, ABC costingstarts with accumulation of overhead costs for each of the resource activities of an organization, and then assignment of these costs to various activity drivers based on their usage of the resource activity, the conventional costing method uses a single plantwide rate for overhead allocation, which here is based on the estimated annual no. of units produced by Besto Company. Further, a company that has only one product line is indifferent between the two approaches, but companies with more than 1 product line should definitely use ABC for accurate level of costs of the product. Page |2
Name:Student ID: Benefits, Costs and Limitation of ABC Method: ABC do not use a flat rate to allocate the overhead and instead use usage based approach to compute the accurate allocation based on usage of activity. Thus, it is more accurate evaluation of product cost. This accurate cost is pivotal to any organization for their decision making on product pricing and gives them an edge while negotiating with the clients. The accurate costs help the company in better decision making by controlling and monitoring costs. The cost of implementing the ABC is substantial but the benefits ensure that the NPV of implementing ABC is positive. The limitation of the approach is that the process takes substantial time and cost at the initial phase. ABC and Traditional Method for Besto Company Inthe given case, ABC or the activity based costing provides more accurate data onthe cost incurred to produce the two varieties of cheese.The comparison of costs under both these methods is as below: ParticularsCheddarMascarpone Per unit Cost - Conventional$10.7938$11.5438 Per unit Cost - ABC$10.1037$26.1838 Selling Price per unit$9.0000$12.0000 Profit per unit - ABC-$1.1037-$14.1838 Profit per unit - Conventional-$1.7938$0.4563 (Please refer Annexure 1 and 2 for per unit costs of the product under ABC) We see that the ABC has given a result which is different from the conventional method that the company has been following. The conventional method estimated that the cost to manufacture one unit of Mascarpone is $11.5438 whereas ABC revealed the true cost as $26.1838. Further for cheddar, the conventional method estimated a higher amount. This is indicative of the fact that under conventional method more of overheads were allocated to the cheddar as the no. of units produced are more which not the true representation of costs is. This leads to inaccurate pricing of the products. Recommendation for Besto Company Page |3
Name:Student ID: The major point of distinction between using plantwide rate and activity rates is the allocation of the overhead to the production. The activity rates method apportions the overhead to the production based on usage and thus is an accurate measure of costs. My recommendation to the company is to adopt the Activity Based Costing method as it gives costs that are more accurate, realistic and reliable. Page |4
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Name:Student ID: Annexure 1: Computation of per unit cost of Cheddar For Cheddar - Computation of Cost Activities ConsumedAnnual Qty of activity driverActivity driverActivity Driver RateCost allocated Corporate managementNANANA$45,771.0000 Process receivables300invoices$53.3531$16,005.9375 Process payables100purchase orders$69.9894$6,998.9375 Production planning180 production schedules$266.7656$48,017.8125 Reports to Health Dept18reports$350.6942$6,312.4961 Process sales order320sales orders$113.7539$36,401.2500 Dispatch sales order300dispatches$99.7156$29,914.6875 New Product DevelopmentNANANA$0.0000 Inspect Milk180Batches$137.6487$24,776.7660 Disposal of substandard milk180Batches$34.9861$6,297.4961 Move to pasteurizing room180Batches$34.7361$6,252.4961 Set up pasteurizer180Batches$158.3156$28,496.8125 Weigh and sort ingredients180Batches$158.3156$28,496.8125 Load pasteurizer25,750litres$6.2162$1,60,068.2363 Operate pasteurizer180Batches$302.4438$54,439.8750 Unload and Clean pasteurizer180Batches$158.3156$28,496.8125 Move to culturing room180Batches$172.5047$31,050.8438 Set up scales180Batches$86.2531$15,525.5625 Weigh ingredients180Batches$158.3156$28,496.8125 Load culturing vats180Batches$316.1641$56,909.5313 Coagulate, Drain and Scald25,750litres$7.4432$1,91,662.6816 Drain and clean vats180Batches$172.5047$31,050.8438 Move to curing room25,750litres$0.5022$12,931.9316 Pack and pressing1,02,400Products$0.4265$43,671.6000 Setup curing room1,030trays$7.6428$7,872.0566 Move to curing room1,030trays$4.2648$4,392.7891 Cure products1,030trays$53.0546$54,646.2275 Unload curing room1,030trays$4.2648$4,392.7891 Inspect finished products0trays$4.4230$0.0000 Disposal of substandard product0trays$2.1866$0.0000 Move to truck1,030trays$5.4217$5,584.3361 Total Allocated Cost$10,14,935.4334 Add: Direct Materials25,750litres$1.0000$25,750.0000 Total Cost$10,40,685.4334 Annual Volume1,03,000 Per Unit Cost of Cheddar (Total Cost/Annual Volume)$10.1037 Page |5
Name:Student ID: Annexure 2: Computation of per unit cost of Mascarpone For Mascarpone - Computation of Cost Activities Consumed Annual Qty of activity driver Activity driver Activity Driver Rate Cost allocated Corporate managementNANANA$5,555.0000 Process receivables100invoices$53.3531$5,335.3125 Process payables100purchase orders$69.9894$6,998.9375 Production planning30 production schedules $266.765 6$8,002.9688 Reports to Health Dept5reports $350.694 2$1,753.4711 Process sales order100sales orders $113.753 9$11,375.3906 Dispatch sales order100dispatches$99.7156$9,971.5625 New Product DevelopmentNANANA$56,237.0000 Inspect Milk50Batches $137.648 7$6,882.4350 Disposal of substandard milk50Batches$34.9861$1,749.3045 Move to pasteurizing room50Batches$34.7361$1,736.8045 Set up pasteurizer50Batches $158.315 6$7,915.7813 Weigh and sort ingredients50Batches $158.315 6$7,915.7813 Load pasteurizer6,250litres$6.2162$38,851.5137 Operate pasteurizer50Batches $302.443 8$15,122.1875 Unload and Clean pasteurizer50Batches $158.315 6$7,915.7813 Move to culturing room50Batches $172.504 7$8,625.2344 Set up scales50Batches$86.2531$4,312.6563 Weigh ingredients50Batches $158.315 6$7,915.7813 Load culturing vats50Batches $316.164 1$15,808.2031 Coagulate, Drain and Scald6,250litres$7.4432$46,520.0684 Drain and clean vats50Batches $172.504 7$8,625.2344 Move to curing room6,250litres$0.5022$3,138.8184 Pack and pressing12,800Products$0.4265$5,458.9500 Setup curing room260trays$7.6428$1,987.1211 Move to curing room260trays$4.2648$1,108.8594 Cure products260trays$53.0546$13,794.1934 Unload curing room260trays$4.2648$1,108.8594 Inspect finished products260trays$4.4230$1,149.9773 Disposal of substandard product260trays$2.1866$568.5240 Move to truck250trays$5.4217$1,355.4214 Total Allocated Cost$3,14,797.1338 Add: Direct Materials6,250litres$2.0000$12,500.0000 Page |6