Case 4: Distortions Caused By Inappropriate Allocation Base Chocolate Bars, Inc.
Case Background. Chocolate Bars, inc. (CBI) manufactures chocolate candy bars with three variants – Almond Dream, Krispy Krackle, and Creamy Crunch. There are 2 distinct production processes for each product of CBI. Process 1 is labor intensive using a high proportion of direct materials and labor. Process 2 uses special packing equipment that wraps individual candy bars and packs it into a box of 24 bars. After which, the boxes are packed into cases of 6 boxes (144 candy bars). This special packing equipment is used for the three products and has a monthly capacity of 3000 boxes, each containing 144 bars.
Despite the company’s profitability as a whole, CBI’s management is concerned with the profitability of each product and the product costing method currently employed. The management questions whether the overhead allocation base of direct labor hours accurately reflects the cost incurred in the production of each product.
Initial report by the cost accountant shows that Creamy Crunch is profitable whereas Almond Dream is at a loss. Both the marketing manager and the cost accountant believe that Almond Dream performs very well at its current market price and that their current cost accounting system is at fault. They have employed a management consultant to assess the process.
Problem Statement. The group will take the view of the management consultant to determine whether using the direct labor hours for each product produced as the overhead allocation base reflects the cost of production of Almond Dream, Krispy Krackle, and Creamy Crunch.
Methodology. Information were gathered using the current cost accounting system using the simplistic single overhead allocation base, which is the direct labor hours, to calculate and apply overhead rates to all products. The rate is calculated by summing the variable and fixed overhead cost and then dividing the result with the...
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