Hi My Question in an Mid Term Exam ?as you can see in attached file and I need an answer today.
Case Study #1
Traditional Versus ABC Systems
Patties Pastries, Inc., (PPI) produces a variety of premium cheesecakes and sells them in
individual packages directly to retail customers and in packages of 10 cakes to restaurants in
New York, New Jersey, Pennsylvania, and Delaware. PPI started as a small retail outlet, where it
developed a superb reputation for quality. In the late 2000s it opened a chain of retail outlets.
Only recently it started selling cheesecakes to restaurants. Its penetration into the restaurant
market has been slower than predicted.
Although PPI produces several types of cheesecakes, all are about the same size and are
considered a single product for costing purposes. PPI?s existing costing system has a single
direct-cost category, ingredients, and a single indirect-cost pool, production overhead costs.
The system does not trace labor costs to the products; it considers them part of production
overhead. Production overhead costs are allocated on the basis of number of cheesecakes
produced. The 2015 budget projected production of 700,000 cheesecakes, 500,000 for the
retail market and 200,000 for restaurants. Predicted costs were as follows:
In early 2014 PPI had unsuccessfully bid for a large restaurant contract from the Ruby
Tuesday?s chain. Its bid had been 30% above that of the successful bidder. This came as a shock
because PPI had budgeted only a small profit into the bid. In addition, the PPI plant was one of
the newest and most efficient in the industry.
Before completing the budget for 2015, top management of PPI asked Viola Temple,
controller of PPI, to examine the company?s cost accounting system. Viola had attended a short
course by the Institute of Management Accountants on activity-based costing (ABC), and she
thought some of the principles of ABC might apply to PPI. She felt that accounting for the
ingredients was not a problem; the ingredients cost the same whether a cheesecake was
produced for retail or restaurant markets. However, when she analyzed production overhead
costs, she saw several possible improvements.
Viola found that production overhead costs could be divided into cost pools for four
activities: 1) administration, 2) facilities operations and maintenance, 3) mixing/baking, and 4)
decorating/packaging. The activities in administration and facilities operations and
maintenance do not involve working directly on cheesecakes, but they support the areas in
which the cheese-cakes are produced. Mixing/baking and decorating/packaging are the
activities that directly produce the cheesecakes. Viola described the four activities as follows:
Administrative: Three administrative employees work in a 600 sq. ft. office providing a variety
of services to PPI, including accounting, personnel, etc. It is difficult to measure the amount of
administrative services provided to each product, but they are roughly proportional to the
number of employees. The administrative costs are budgeted at $125,000 for 2015.
Facilities Operations and Maintenance: Two employees, located in an 800 sq. ft. office wing,
operate and maintain the facilities. In addition, rent and depreciation charges and the cost of
supplies for operating and maintaining the facilities are included in this cost pool. These
facilities operations and maintenance costs are closely related to the number of square feet of
space used. Budgeted facilities operations and maintenance costs for 2015 are $345,000.
Mixing and Baking: Six employees are located in 6,500 sq. ft. of space with a capacity to
produce 900,000 cheesecakes per year. Much of the mixing and baking operation is the same
for all cheesecakes produced. However, the cheesecakes sold through PPI?s own retail outlets
require some special handling to give them a distinctive quality. The production line produces
95 retail cheesecakes per processing-hour and 145 restaurant cheesecakes per processing hour.
Costs are driven by the number of processing-hours. Budged costs in mixing and baking for
2012 are $585,000.
Decorating and Packaging: Decorating and packaging require three employees and 1,800 sq. ft.
of space. There are two separate decorating/packaging lines. Only 25 retail cheesecakes can be
decorated and packaged per hour, while 75 restaurant cheesecakes can be decorated and
packaged in the same amount of time. Costs vary with the number of decorating/packaging
hours. Budgeted costs for 2012 were $1,320,000. Of this total cost, $364,000 was for packaging
materials that could be traced to individual products, $345,000 to retail, and $19,000 to
1. Use the existing costing system to find the budgeted cost per cheesecake for the retail
market and the restaurant market. Comment on the weaknesses of this system.
2. Use the ABC system to find the budgeted cost per cheesecake for (a) the retail market and
(b) the restaurant market.
3. Explain why the cost per cheesecake is different when applying the Traditional vs ABC