Gourmet Coffee vs Specialty Coffee

Gourmet Specialty Coffee Company (GSCC)

5-55 1 (a).
Overhead rate: $10 per direct-labor dollar
2. New product cost: $11.06 per pound of Jamaican coffee Gourmet Specialty Coffee Company (GSCC) 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. GSCC currently has 12 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.

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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. GSCC 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 price-conscious as well. Data for the 20×5 budget include manufacturing overhead of $12,000,000, which has been allocated on the basis of each product’s direct-labor cost.

The budgeted direct-labor cost for 20×5 totals $1,200,000.

Based on the sales budget and raw-material budget, purchases and use of raw materials (mostly coffee beans) will total $5,800,000.

The expected prime costs for one-pound bags of two of the company’s products are as follows: | |Jamaican |Colombian | |Direct material |$2. 0 |$3. 90 | |Direct labor |. 40 |. 40 | GSCC’s controller believes the traditional product-costing system may be providing misleading cost information. She has developed an analysis of the 20×5 budgeted manufacturing-overhead costs shown in the following chart. |Activity |Cost Driver Budgeted Activity |Budgeted Cost | |Purchasing |Purchase orders |2,316 |$2,316,000 | |Material handling |Setups |3,600 |2,880,000 | |Quality control |Batches |1,440 |576,000 | |Roasting |Roasting hours |192,200 |3,844,000 | |Blending |Blending hours |67,200 |1,344,000 | |Packaging |Packaging hours |52,000 |1,040,000 | |Total manufacturing-overhead cost | | | | | | | |$12,000,000 | Data regarding the 20×5 production of Jamaican and Colombian 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.

Figures in blue for 2,000 lb. for Jamaican and 100,000 lb. for Colombian | |Jamaican |Colombian | |Budgeted sales |2,000 lb. |100,000 lb. | |Batch size |500 lb. (4 batches) |20,000 lb. (5 batches) | |Setups |3 per batch (total 3X4=12) |3 per batch (15 setups) | |Purchase order size |500 lb. 4 orders) |50,000 lb. (2 orders) | |Roasting time |1 hr. per 200 lb. (10 hrs for 2,000 lb. ) |1 hr. per 200 lb. (500 hrs in total) | |Blending time |. 5 hr. per 200 lb. (5 hrs) |. 5 hr. per 200 lb. (250 hrs) | |Packaging time |. 1 hr. per 200 lb. (1 hr) |. 1 hr. per 200 lb. (50 hrs) | Required: 1. Using GSCC’s current product-costing system: a. Determine the company’s predetermined overhead rate using direct-labor cost as the single cost driver.

Predetermined overhead rate = Estimated overhead/estimated direct labor cost Estimated overhead = $12,000,000 Estimated overhead cost = 1,200,000 Predetermined overhead rate = $12,000,000/1,200,000 = $10 per $ of Direct Labor b. Determine the full product costs and selling prices of one pound of Jamaican coffee and one pound of Colombian coffee. | |Jamaican |Columbian | |Direct material |$2. 90 |$ 3. 90 | |Direct labor |. 40 |. 0 | |Overhead (0. 40X$10) | 4. 00 | 4. 00 | |Full product cost |$7. 30 |$8. 30 | |Markup (30%) |2. 19 |2. 49 | |Selling price |$9. 49 |$10. 79 | 2. Develop a new product cost, using an activity-based costing approach, for one pound of Jamaican coffee and one pound of Colombian coffee.

In activity based costing, we find the activity rate as Activity rate = Total activity/Total cost of activity. Using the activity usage by the products, the cost is allocated. The activity rates are calculated below | | |Budgeted Activity (1) |Budgeted Cost (2) | | |Activity |Cost Driver | | |Activity Rate | | | | | |(2/1) | |Purchasing |Purchase orders |2,316???? $2,316,000 |$1,000 | |Material handling |Setups |3,600 |2,880,000 |800 | |Quality control |Batches |1,440 |576,000 |400 | |Roasting |Roasting hours |192,200 |3,844,000 |20 | |Blending |Blending hours |67,200 |1,344,000 |20 | |Packaging |Packaging hours |52,000 |1,040,000 |20 | In the second step we charge the cost to the products based on activity usage. The cost of Jamaican coffee is |Direct material |$2. 90 | |Direct labor |. 40 | |Purchasing (4 orders ( $1,000/2,000 lb. ) |2. 00 | |Material handling (12 setups ( $800/2,000 lb. ) |4. 0 | |Quality control (4 batches ( $400/2,000 lb. ) |. 80 | |Roasting (10 hours ( $20/2,000 lb. ) |. 10 | |Blending (5 hours ( $20/2,000 lb. ) |. 05 | |Packaging (1 hours ( $20/2,000 lb. ) |??. 01 | |Total cost |$11. 06 |

Each purchase order is for 500 lb. and so for total sales of 2,000 lb. , there will be 4 purchase orders. In the same way for setups and batches. The cost of Columbian coffee is |Direct material |$3. 90 | |Direct labor |. 40 | |Purchasing (2 orders ( $1,000/100,000 lb. ) |. 02 | |Material handling (15 setups ( $800/100,000 lb. ) |. 12 | |Quality control (5 batches ( $400/100,000 lb. |. 02 | |Roasting (500 hours ( $20/100,000 lb. ) |. 10 | |Blending (250 hours ( $20/100,000 lb. ) |. 05 | |Packaging (50 hours ( $20/100,000 lb. ) |??. 01 | |Total cost |$4. 62 | There will be 2 purchase orders as total sales are 100,000 lb. nd we buy 50,000 lb. in each purchase order. 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? Activity based costing shows that costs move with many different bases and not on one (direct labor cost). Using only a single cost driver, we were under costing Jamaican and over costing Columbian. b. The use of the existing product-costing system as the basis for pricing? The existing basis for pricing was not correct since the costing was not correct. We need to reprice the products based on the costs calculated under activity based costing.

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