Ecratic Company: Improving Cost Management with Activity Based Costing

This case study examines Ecratic Company's costing system, highlighting the deficiencies in its conventional costing method and advocating for the implementation of Activity Based Costing (ABC). The analysis reveals that the company's traditional job costing system, which allocates overheads based on a single plant-wide rate, leads to inaccurate product costs and misinformed pricing decisions, particularly for its diverse ice cream product lines. By transitioning to ABC, the company can identify and allocate costs more accurately based on the actual consumption of resources by each product. The study demonstrates how ABC provides a more reliable measurement of product costs, improves pricing strategies, and ultimately enhances profitability, as evidenced by the significant changes in per-unit costs for Classic Vanilla and Butter Pecan under both costing systems. Desklib provides students access to this document and many more solved assignments and past papers.

Student No. 297012, Name: Mr. Hussein Rkein 2019
Introduction:
Ecratic Company is a manufacturer of wide range of Ice-creams in the country. The company
is in the business for last 20 years producing ice creams ranging from traditional Classic
Vanilla, Classic Chocolate, and Classic Rainbow to new flavours like Gourmet Vanilla Bean,
Butter Pecan and Coconut Vanilla Gelato.
The company was using conventional costing system wherein all the overheads of the
company was distributed to the product lines based on the total number of units
manufactured. Off late the company is struggling with keeping the same level of profits and
thus the senior management is concerned about the productivity of the employees.
We have critically analysed the company’s costs and there are deficiencies in the company’s
conventional costing system that the company currently adheres to.
Assignment of costs to activity centres:
Resource Driver Cost allocation
Cost
Category Wages
Building
Cost
Depreciat
ion
Consu
mables Energy Others
Total Cost
Activity
Centres (employees) (m2)
(Machine
Hours)
(Order
s)
(Kilow
att
Hours)
(employ
ees)
Product
Development
$1,71,586.1
345
$81,268.6
567 $0.0000
$1,120.
3704
$2,842.
2819
$1,525.2
101
$2,58,342.6
535
Sales and
Distribution
$6,86,344.5
378
$1,89,626
.8657 $0.0000
$1,120.
3704
$3,410.
7383
$6,100.8
403
$8,86,603.3
524
Inspecting
$1,14,390.7
563
$1,89,626
.8657 $0.0000
$1,120.
3704
$3,410.
7383
$1,016.8
067
$3,09,565.5
373
Pasteurizing
$17,15,861.
3445
$3,52,164
.1791
$4,84,000.
0000
$20,16
6.6667
$68,21
4.7651
$15,252.
1008
$26,55,659.
0562
Mixing
$17,15,861.
3445
$3,52,164
.1791
$6,05,000.
0000
$13,44
4.4444
$1,02,3
22.147
7
$15,252.
1008
$28,04,044.
2166
Freezing
$13,72,689.
0756
$3,52,164
.1791
$1,21,000.
0000
$20,16
6.6667
$68,21
4.7651
$12,201.
6807
$19,46,436.
3672
Administrati
on
$6,86,344.5
378
$1,89,626
.8657 $0.0000
$2,240.
7407
$2,842.
2819
$6,100.8
403
$8,87,155.2
664
Corporate
Management
$3,43,172.2
689
$1,08,358
.2090 $0.0000
$1,120.
3704
$2,842.
2819
$3,050.4
202
$4,58,543.5
503
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Student No. 297012, Name: Mr. Hussein Rkein 2019
Assignment of costs to each activity under Pasteurizing Activity Centre:
Cost of Each Activity within the Activity Centre - Pasteurizing
Activity Wages
Buildin
g Cost
Depreci
ation
Consum
ables Energy Others
Total
Cost
Set up
Pasteurizer
$1,71,58
6.1345
$17,60
8.2090
$1,525.2
101
$1,90,71
9.5535
Weigh and
Sort
Ingredients
$1,71,58
6.1345
$17,60
8.2090
$1,525.2
101
$1,90,71
9.5535
Load
pasteurizer
$6,86,34
4.5378
$2,46,5
14.925
4
$20,166.
6667
$6,100.8
403
$9,59,12
6.9702
Operate
pasteurizer
$3,43,17
2.2689
$17,60
8.2090
$4,84,00
0.0000
$68,214.7
651
$3,050.4
202
$9,16,04
5.6631
Unload and
Clean
pasteurizer
$1,71,58
6.1345
$17,60
8.2090
$1,525.2
101
$1,90,71
9.5535
Move to
mixing room
$1,71,58
6.1345
$35,21
6.4179
$1,525.2
101
$2,08,32
7.7624
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Student No. 297012, Name: Mr. Hussein Rkein 2019
Computation of per unit Cost using Bill of Activities: Classic Vanilla
Bill of activities - Cost for Classic Vanilla
Activities Consumed Annual Qty of
activity driver Activity driver Activity
Driver Rate Cost allocated
Corporate management NA NA NA $91,898.0000
Process receivables 600 invoices $58.1741 $34,904.4590
Process payables 200 purchase orders $111.8717 $22,374.3333
Production planning 170
production
schedules $162.5438 $27,632.4463
Reports to Health Dept 170 reports $25.2091 $4,285.5455
Process sales order 610 sales orders $117.3225 $71,566.7376
Dispatch sales order 500 dispatches $105.1173 $52,558.6667
Product Development NA NA NA $0.0000
Inspect cream 170 Batches $106.9719 $18,185.2231
Disposal of substandard
cream 170 Batches $25.2091 $4,285.5455
Move to pasteurizing room 170 Batches $25.2091 $4,285.5455
Set up pasteurizer 170 Batches $157.6195 $26,795.3092
Weigh and sort ingredients 170 Batches $157.6195 $26,795.3092
Load pasteurizer 48,500 litres $3.9633 $1,92,221.7275
Operate pasteurizer 170 Batches $757.0625 $1,28,700.6304
Unload and Clean pasteurizer 170 Batches $157.6195 $26,795.3092
Move to mixing room 170 Batches $172.1717 $29,269.1898
Set up scales 170 Batches $86.0860 $14,634.6116
Weigh ingredients 170 Batches $157.6198 $26,795.3719
Load mixers 170 Batches $315.2388 $53,590.6033
Operate mixers 48,500 litres $7.4282 $3,60,267.2190
Clean mixers 170 Batches $172.1719 $29,269.2231
Move mixture to freezer 48,500 litres $0.5032 $24,404.7190
Load hopper 1,93,600 Products $0.4486 $86,852.8000
Set up packaging and fill 1,940 trays $8.0629 $15,641.9514
Move to freezer 1,940 trays $4.4862 $8,703.2448
Freeze products 1,940 trays $55.6771 $1,08,013.6085
Unload freezer 1,940 trays $4.4862 $8,703.2448
Inspect finished products 0 trays $2.7678 $0.0000
Disposal of substandard
product 0 trays $1.5756 $0.0000
Move to truck 1,940 trays $5.3957 $10,467.6829
Total Allocated Cost $15,09,898.2579
Add: Direct Materials 48,500 litres $2.0000 $97,000.0000
Total Cost $16,06,898.2579
Annual Volume 1,94,000
Per Unit Cost of Classic Vanilla (Total Cost/Annual Volume) $8.2830
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Student No. 297012, Name: Mr. Hussein Rkein 2019
Computation of per unit Cost using Bill of Activities: Butter Peccan
Bill of activities - Cost for Butter Peccan
Activities Consumed Annual Qty of
activity driver Activity driver Activity
Driver Rate Cost allocated
Corporate management NA NA NA $11,132.0000
Process receivables 200 invoices $58.1741 $11,634.8197
Process payables 100 purchase orders $111.8717 $11,187.1667
Production planning 60
production
schedules $162.5438 $9,752.6281
Reports to Health Dept 60 reports $25.2091 $1,512.5455
Process sales order 180 sales orders $117.3225 $21,118.0537
Dispatch sales order 100 dispatches $105.1173 $10,511.7333
Product Development NA NA NA $85,253.0000
Inspect cream 50 Batches $106.9719 $5,348.5950
Disposal of substandard cream 50 Batches $25.2091 $1,260.4545
Move to pasteurizing room 50 Batches $25.2091 $1,260.4545
Set up pasteurizer 50 Batches $157.6195 $7,880.9733
Weigh and sort ingredients 50 Batches $157.6195 $7,880.9733
Load pasteurizer 11,750 litres $3.9633 $46,569.1814
Operate pasteurizer 50 Batches $757.0625 $37,853.1266
Unload and Clean pasteurizer 50 Batches $157.6195 $7,880.9733
Move to mixing room 50 Batches $172.1717 $8,608.5852
Set up scales 50 Batches $86.0860 $4,304.2975
Weigh ingredients 50 Batches $157.6198 $7,880.9917
Load mixers 50 Batches $315.2388 $15,761.9421
Operate mixers 11,750 litres $7.4282 $87,281.2335
Clean mixers 50 Batches $172.1719 $8,608.5950
Move mixture to freezer 11,750 litres $0.5032 $5,912.4835
Load hopper 24,200 Products $0.4486 $10,856.6000
Set up packaging and fill 490 trays $8.0629 $3,950.8022
Move to freezer 490 trays $4.4862 $2,198.2423
Freeze products 490 trays $55.6771 $27,281.7877
Unload freezer 490 trays $4.4862 $2,198.2423
Inspect finished products 490 trays $2.7678 $1,356.2319
Disposal of substandard
product 490 trays $1.5756 $772.0284
Move to truck 470 trays $5.3957 $2,535.9850
Total Allocated Cost $4,67,544.7273
Add: Direct Materials 11,750 litres $4.0000 $47,000.0000
Total Cost $5,14,544.7273
Annual Volume 23,500
Per Unit Cost of Butter Peccan (Total Cost/Annual Volume) $21.8955
Use of Conventional Costing System:
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Student No. 297012, Name: Mr. Hussein Rkein 2019
The current costing system been followed in the company is Job costing method. This is one
of the simplest methods of costing approaches wherein the total costs incurred by the
company (Direct Material, Direct Labour and Manufacturing overheads) are applied to the
production on one uniform basis. Thus uniform basis can be labour hours, no. of products,
machine hours or any one single base for allocation of all the costs to the products
manufactured by the company. (Bragg, 2019)
With the use of the current system the cost of the product works out to be as below:
Computation of Per unit Cost
Particulars For Classic
Vanilla
For Butter
Peccan
Estimated Annual units produced 23,500 1,94,000
Direct Material $97,000 $47,000
Overhead Allocated (No. of Units * Plant wide rate) $2,47,778 $20,45,488
Total Cost $3,44,778 $20,92,488
Per unit Cost (Total Cost/Units) $14.6714 $10.7860
(For computation of Plant wide Rate refer annexure 1)
Deficiency in the current Conventional Costing System:
The per unit cost of the products are comparable whereas the efforts required in both the
variety are not. This is the most critical deficiency in the current system which reveals
misguiding per unit cost and thus results into inaccurate pricing of the product leading to loss
of sale ultimately.
Use of Activity Based Costing System:
This deficiency in the system can be improved or overcome by use of Activity based costing.
Activity Based Costing is a more logical and robust method of allocating costs to the
products. The ABC method begins with identification of activities that are culminating into
costs for the company. The identified costs are then apportioned between each product based
on the usage or actual consumption of the resource by the products (AccountingCoach.com,
2019)
The benefits of using ABC in a manufacturing concern are:
a. ABC method provides reliable and accurate measurement of product costs by
focusing on actual consumption of resources by the product (Agarwal, 2019).
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Student No. 297012, Name: Mr. Hussein Rkein 2019
b. It uses multiple activity drivers and then allocates the cost basis the usage of the
resource drivers and not merely on volume of production. (Agarwal, 2019).
c. ABC is simple and easy to understand. The companies using ABC have more accurate
and relevant cost of the product thus giving them an edge on pricing the product
accurately (Ayres, 2019)
ABC is more accurate in allocating the cost to various products being manufacture by the
company. It identifies the activities of cost for the company and then computes the total cost
for each such activity. ABC in contrast to conventional costing system do not use a single
plant wide rate for allocation of the total overhead of the company. ABC identifies each and
every activity and then their cost and then allocates them to product basis the usage of the
activity by the product. This leads to no duplication or omissions. Thus, ABC is a more
accurate and robust approach of assigning cost of the resources to the products.
The ABC is difficult and expensive to implement but once implemented its benefits surpasses
the cost incurred and gives the company a competitive edge. For Ecratic Company, we saw a
similar computation.
Conventional Costing System vs Activity Based Costing:
Under ABC costing the per unit cost of the products haven been worked as below:
 The Classic vanilla is computed as $8.2380 whereas under conventional costing
system it was $14.6714.
 The Butter pecan is computed as $21.8955 whereas under conventional costing
system it was $10.7860.
We clearly see that for butter peccan the per unit cost has increased by 103% from $10.7860
per unit to $21.8955 per unit. Further, for classic Vanilla it has decreased by 43% from
$14.6714 to $8.2380. This has happened because when we shift from convention costing
method to ABC the costs of the company are allocated on the basis of usage of the activity
and not simply on number of units produced.
The application of ABC for the company revealed that Butter pecan actually uses more
resources of the company and has a product cost of $21.8955 whereas it is sold for only $13
per unit. The sale price of $13 was fixed based on the cost of $10.7860 under conventional
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Student No. 297012, Name: Mr. Hussein Rkein 2019
costing system. But this is inaccurate as butter pecan is using more resources and is
expensive. ABC helped the company identifying the true reason of declining profitability
Similar, for classic vanilla the cost is much less as it is less recourses.
The cost allocation for overheads differs significantly under both the products namely classic
vanilla and Butter Peccan because of the difference in allocation of overheads under both the
methods.
Changes in the cost structure of the company:
The company cost structure has changed significantly in the last 15 years owing to
introduction of various product lines, changing technology, introduction of fresh talent,
increasing competition in the market, changing consumer needs and wants. The most
important change in the company’s cost structure was undoubtedly introduction of ABC for
allocation of overheads. This is because the declining profits forced the company to believe
that there are problems in pricing of the product and to streamline the prices, the accurate
costs were needed which was possible by ABC.
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Student No. 297012, Name: Mr. Hussein Rkein 2019
Annexures
Annexure – 1: Computation of Plant wide Rate under Conventional Costing System:
Conventional Costing System - Plantwide Rate
Cost Category Cost
Wages $68,06,250
Building Cost $18,15,000
Depreciation $12,10,000
Consumables $60,500
Energy $2,54,100
Others $60,500
Total Overheads $1,02,06,350
Estimated Annual number of Units 9,68,000
Plantwide Rate
(Total Overhead / Annual Units) $10.5438
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Student No. 297012, Name: Mr. Hussein Rkein 2019
References
Agarwal, R. (2019). Advantages and Demerits of Activity Based Costing (ABC). Your Article
Library. Retrieved from
http://www.yourarticlelibrary.com/accounting/costing/advantages-and-demerits-of-
activity-based-costing-abc/52617 on 17th May 2019.
Ayres, C. (2019). 8 Pros and Cons of Activity Based Costing. [Blog] Green Garage.
Retrieved from https://greengarageblog.org/8-pros-and-cons-of-activity-based-costing on
17th May 2019
AccountingCoach.com. (2019). Activity Based Costing | Explanation | AccountingCoach.
Retrieved from https://www.accountingcoach.com/activity-based-costing/explanation on
17th May 2019
Bragg, S. (2019). Job costing. [online] AccountingTools. Retrieved from
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Copeland, R. (2000). Managerial accounting. Houston, TX: Dame.
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Lucey, T. (2009). Costing. Australia: South-Western Cengage Learning.
Turney, P. (1997). Activity based costing. London: Kogan Page.
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