Performance Drinks, LLC is owned by Dave N. Port. Performance Drinks produces a
ID: 2422362 • Letter: P
Question
Performance Drinks, LLC is owned by Dave N. Port. Performance Drinks produces a variety of sports centered drinks. They began operations in 1993 shortly after Mr. Port graduated with his M.B.A. from Davenport University. The company saw early success as sports and fitness nutritional products gained new popularity in the 1990’s. Financially the company is sound and has been wise in controlling their growth over the years. However, within the last 18 months Mr. Port has noticed a drop in overall company profitability. This is especially troubling considering that the company has continued to experience top-line growth. Mr. Port and his management team have been considering developing a new product line. However, those plans have been put on hold until they can figure out why their profits are shrinking.
Performance Drinks makes four different kinds of sports drinks. Those drinks are as follows:
Basic
Hydration
Intensity
Post-Workout
Each of these drinks contains a slightly different nutritional profile and is targeted for different users and uses. The Basic drink has the least nutritional benefit and is targeted for general consumption. The Hydration product targets endurance athletes and specializes in hydration replacement. The Intensity product was designed with energy enhancement in mind. It serves the needs of extreme athletes who need long durations of sustained energy. Lastly, the Post-Workout product is a nutritional replacement product that is generally used following exertion.
Information Related to Case #2
You are the Controller for Performance Drinks. You feel as though you have a good handle on the financial reporting and the overall company performance. However, admittedly, your accounting information system has been designed to serve the needs of external users from an aggregate perspective. To that end you utilize absorption costing exclusively within the organization. You recall studying the concept of Activity Based Management (ABM) and Activity Based Costing (ABC) while taking a managerial accounting course. You wonder if applying those ideas to your business would help to uncover the mystery of the disappearing profits.
You recall from your Management Accounting class that product costs are comprised of:
Direct Materials
Direct Labor
Manufacturing Overhead
You don’t suspect that anything strange is going with your direct costs. You do wonder, however, if a more thorough understanding of your indirect costs may be in order. Over a series of weeks you talk with a variety of employees, representing a multitude of functional areas, from within the company. During those conversations you take careful note on what activities might be consuming resources and how those activities might be measured. You sharpen your pencil and begin to unpack what you’ve learned. You start with reviewing last month’s Product-Level Profit Report. That report is following:
Overhead Activities:
Using traditional costing methods, which support your absorption costing system, you base overhead allocation on direct labor cost. Furthermore, “fringe benefits” are a function of direct labor cost.
As a result of your many meetings to discuss company overhead you determine that the majority of your indirect costs are related to four primary activities. Those activities are equipment set-ups, production runs, production management and machine-hour capacity. “Production Management” refers to a number of items that are correlated to the number of products the company produces. Ultimately you determine that your key activities have the following usage patterns, as they pertain to the monthly overhead costs:
New Information Pertaining to Case #3:
The financial reporting to date has been done using absorption costing. That is to say that the manufacturing costs included direct materials, direct labor, variable manufacturing overhead and fixed manufacturing overhead. In this sense the Income Statements have historically reported Gross Margin. Following is a Monthly Income Statement, based on absorption costing, for Performance Drinks:
You begin to wonder if there would be any value in repackaging the income statement in a way that would report Contribution Margin as opposed to Gross Margin. You know that in order to report Contribution Margin you will need to understand your costs as variable and fixed. Unfortunately the general ledger does not specifically report costs as variable and fixed. You remember learning that regression analysis can be used to generate data that can be used to create a total cost equation. With the total cost equation we can understand our total cost as the sum of fixed costs and variable costs. After doing some research your collect the following data related to overhead and possible causal factors:
Case Study Investigations:
1. Compute the cost driver rates for each of the four activities.
2. Compute the per unit product costs for each of the four products, using ABC allocation for overhead.Show the computation for each per unit product cost in detail.
3. Prepare a “Monthly Profit Report”. Create this report using the results of the ABC overhead allocation.
4. Prepare a written “Management Report” that explains to the management team what Activity Based Costing is, how it was used to generate the Monthly Profit Report. Explain why the profit for each product is different when comparing the Traditional report with the ABC report.Explain what the company might consider doing, based on all of this information, to stop the erosion of company profits.
Additional Case Study Investigations:
5. What would happen to costs if plant capacity was shifted from 20,000 machine-hours a month to 40,000 machine-hours per month.
6. Compute the new cost per unit for each of the products considering the increase in capacity.Show the computation for each per unit product cost in detail.
7. What is the cost of the unused capacity if it is assumed that the company has 40,000 machine-hours of capacity but it using 20,000 machine-hours?Including a “Management Report” with a discussion on how to best use the additional capacity.
Explanation / Answer
1.
particulars Monthly equipment production number of machine hour
charges setup runs products capacity
indirect labor 55,000 11,000 24,750 8.250 11,000
frindge benifits 24,750 4,950 11,137.5 3,712.5 4,950
utilities 5,000 250 3,250 0 1,500
equipment depre 10,000 0 10,000 0 0
maintenance 10,000 4,000 3,000 0 3,000
Info technology 23,000 2,300 3,450 16,100 1,150
Total 127,750 22,500 55,587.5 28,062.5 21,600
cost drivers
Equipment setup 22,500 85 setups 264.7per setup
prouction cost 55,587.5 250 production runs 222.35 per production run
Number of prouct 28,062.5 4 production mgnt 7,015.625 per management
machine hour capacity 21,600 20,000 machine hours 1.08 per machine hour
2.
manufacturing overhead basic hydration intensity post workout
Equipment setup (264.7) 3,970.5 3,970.5 13,235 1324
production cost (222.35) 27,793.75 14452.75 7,782.25 5,558.75
number of product (7015.625) 7015.75 7015.75 7015.75 7015.25
Machine hour capacity (1.08) 9,720 4,320 3,240 4,320
Total overheads 48,500 29,759 31,273 18,218
particulars basic hydration intensity post workout total
Direct material 40,000 50,000 31,000 33,000 154,000
Direct labor 25,000 20,000 10,000 18,000 73,000
Fringe benefit direct 11,250 9,000 4,500 8,100 32,850
manuf. overhead 48,500 29,759 31,273 18,218 127,750
Total cost 124,750 108,759 76,773 77,318 387,600
volume 100,000 80,000 45,000 60,000
per unit cost 1.2475 1.36 1.71 1.29