California Creamery, Inc. |
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California Creamery, Inc. (CCI) owned and operated 14 retail ice cream
stores spread throughout Southern California, from San Luis Obispo to
San Diego. CCI's stores sold only the highest quality, ultra-premium
ice cream. They offered 25 different ice cream flavors. Many of the CCI
flavors were “exotic,” such as “Polynesian Fantasy,” “Mango-Lemon
Supreme,” and “Multi-Nut Twist.” But CCI also sold a few traditional
ice cream flavors, such as vanilla, chocolate, strawberry, and coffee.
Some of the flavors were very popular, but a few of the exotic flavors
sold in low volumes.
CCI produced its own ice cream. Originally the ice cream was produced
in the garage of the company's founder, Will Forgey. But the company
outgrew the garage, and Will had since leased a building to house CCI's
production activities. As CCI had grown, Will had been able to afford
more expensive, automated manufacturing equipment that blended the
flavors and packaged the liquid ice cream in preparation for freezing.
CCI's most significant production costs were for raw materials,
particularly cream, sugar, and the special flavor ingredients, and for
the acquisition, operation, and maintenance of the production equipment.
All of CCI's products were sold at the same retail price. Will set the
prices to yield, roughly, a markup of 100% on average full production
costs. CCI's 2004 budget included manufacturing overhead of $600,000.
To estimate product costs, Will spread this overhead cost to products
based on a proportion of the direct labor used in the production
process. CCI's total direct labor cost for 2004 was $300,000, so Will
charged the overhead to products at a rate of 200% of direct labor
costs.
One day in a casual conversation, Louise Fettinger, Will's neighbor and
a controller of a small manufacturing company, suggested that Will's
pricing policy was not very smart. Louise's intuition was that the
costs of producing CCI's various flavors were very different. She
thought those differences should be reflected in the prices charged, or
CCI's profits would vary as the mix of products sold varied.
Assignment
1. Compute the full production cost (per gallon) of the Polynesian Fantasy and Vanilla products using:
a. Will's old costing method;
b. The new costing method (Louise's suggestion).
2. What are the effects, if any, of changing the
company's costing method? Specifically, are the differences between the
two costing methods material in terms of:
a. their effect on individual product costs?
b. their effect on total company profits? (Assume no
changes in any operating decisions, such as prices and production
volumes.)
If there are material differences, why do they
exist? If there are no material differences, why do they not exist?
3. What should Will do now? Explain.
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