Case Study About Product Costing at Fine Foods Is It a Symptom or the Problem

Case Study About Product Costing at Fine Foods: Is It a Symptom or the Problem?

Name：Shizhengqiang

Student Number:2012335810037

Before beginning the analysis to this case, we just have a brief review about the case. This case describes a situation at the Fine Foods, Inc. A manager of strategic marketing unit two (smu2) in the Fine Foods, Inc. is frustrated with what she perceives to be unfair and inappropriate product costing for her unit but has nothing to do because of lack of accounting knowledge. Then after have an accurate reading and understanding, we can have a clear perceive that the major problems Smith faced mainly in the process costing, special orders and performance evaluation.

Firstly, according to the demand, I first list some the relevant glossary of terms and definitions for Smith or reader. See as follow.

term cost driver Product period Fixed variable Direct indirect Incremental and common

Definitions

variable, such as the level of activity or volume, that causally affects cost over a given time span.

vs. A product cost is the sum of the costs assigned to a product for a specific

purpose, while period costs are all costs in the income statement other than cost of goods sold.

vs. Fixed costs are business expenses that are not dependent on the level of

goods or services produced by the business, while variable costs are expenses that change in proportion to the activity of a business. vs. Direct costs are directly attributable to the cost object. Indirect costs are

costs that are not directly accountable to a cost object.

Incremental cost is the cost associated increasing production by one unit. Common cost is a cost that is allocated to two or more cost centers within a company.

Relevant irrelevant

vs. A relevant cost is a cost that differs between alternatives being considered.

A irrelevant cost is a cost incurred by a company which is unaffected by management's decisions.

Controllable vs. A Controllable cost is a cost which can be influenced by its budget holder. Noncontrollable Noncontrollable costs are costs that cannot be controlled by a manager on

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Cost object and Anything for which a measurement is desired. A cost driver is a

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Allocation

whom the responsibility of the cost is vested.

Cost allocation is a process of providing relief to shared service organization's cost centers that provide a product or service. Popular methods are dual allocation, volume allocation, activity-based allocation.

Process Costing

Product-costing procedure at Fine Foods (according to the description in the case):

 Raw material, packaging material, and direct production salaries are added to

determine what Fine Foods calls direct calculated costs.

 Variable manufacturing costs are allocated based on estimates and a mark-up to

cover spoilage and other incalculable costs.

 Most of the fixed production costs are allocated based on the weight.

 Costs for top management, business administration, information systems, human

resources, supply management, and logistics are allocated to product in two steps.

According to the description above, combined with what we learn, we can learn that there exit some problems in it. For example, the variable manufacturing costs allocated based on estimates may not accurate, fixed production costs allocated based on weight is unfair for product MP and special orders are by products, the costs of them should be considered separately. That is to say, the unreasonable cost allocation will lead to enterprise pricing is not reasonable, product profitability is difficult to estimate and the error of production decision-making. Even worse, it may has a directly influence on performance evaluation.

So how can we to do it? According to we have just learned in management accounting, we know that the activity-based costing is more accurate and reasonable

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to allocate the cost than the company used. The activity-based costing focus on activity that allocation of indirect costs based on causal activities and use a separate allocation rate for each activity. In this case, fixed production costs are allocated based on production time or transportation mileage rather than weight, eliminating the unfairness caused by the high density and heavy weight of product MP. Otherwise, for the product (MP), the freight cost is not irrelevant and should be allocated to the period cost and media and sales promotion costs are selling expenses, which belong to period cost. So including them in the product cost is unreasonable. But in the company used allocating method, those costs are allocated to the product, which has the very big hidden trouble. Special Orders

In this case, special orders are those in which the contract specifies that they can be rejected within one year before delivery (mostly the product MP). According to what we learned, the keys to making special decisions are focusing on relevant revenues, costs, profit and using a contribution margin approach that separates variable costs from fixed costs. Thus for Smith, it is proper to make a decision by contribution margin, but SMU2 didn’t consider all the factors when using this method. Such as fixed manufacturing cost should not be considered in decision-making, default cost should be amortized when accepting special orders and special orders were not handled specially. In addition to that, SMU2 accepts special orders just when the contribution margin (CM1) is positive (Fine Foods defines CM1 as net sales minus variable manufacturing costs (defined above) and freight out). However, that is not reasonable.

For special order considerations, it is important to consider that does the

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石争强 12会计3班 学号：2012335810037

company have excess capacity available to fill this order and will the special price be high enough to cover the incremental costs of filling the order? And just when expected increase in revenues exceeds expected increase in variable and the added foxed costs that accept the special order.

Moreover, due to the raw material used to make product MP can be kept in storage for a fairly long time under proper conditions and always have a ready stock on hand because of used in many other products. Thus, for SMU2, it could use a just-in-time system to produce this special order and promote consumer preference to increase the profit. Performance Evaluation

Firstly, according to Peter Jones (the controller of Fine Foods) speaking, the SMUs have the ability to control the costs of their divisions, and other costs are allocated easily and fairly. Targets are established for CM1, CM2, CM3, CM4, and operating profit, and the numbers are reviewed monthly to see if corrective action is necessary. But for smith, Smith feels the method used by Fine Foods to calculate operating profit doesn’t reflect the true performance of the SMUs because unit management can’t control several of the cost elements included in the calculation. Further, she believes using operating profit as the primary indicator for evaluating units has a negative motivational effect on the employees of her unit.

According to the above introduce, and combined with the table 2: contribution margins and operating profit, we can learn that there exit some shortcomings, such as high sales revenue may be followed with high bad debt ratio, some indispensable expenses may be cut down, external environment may influence the performance of SMUs’ managers and financial measures can’t evaluate managers’ hard work on

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石争强 12会计3班 学号：2012335810037

raising the developing potential of the company.

Therefore, some new methods of performance evaluation for the company apparently more appropriate.

Responsibility center. A responsibility center is a part or subunit of an organization whose manager is accountable for specific activities. In a cost center, managers are accountable for cost (expenses) only. The foreman is not responsible for generating revenues because he or she is not involved in selling the product. In a revenue center, managers are primarily accountable for revenue. In a profit center, managers are accountable for both revenues and costs (expenses) and, therefore, profits. Profit center reports include both revenues and expenses to show the profit center’s income and in an investment center, managers are accountable for investments, revenue, and costs (expenses). Investments include assets and cash necessary to run the company. Management must ensure that all company investments are being used wisely and are aligned with the company goals to provide a strong profit.

The Balanced Scorecard. The balanced scorecard recognizes that management must consider both financial performance measures and operational performance measures when judging the performance of a company and its subunits. Those measures linked with the company’s goal and its strategy for achieving those goals. The balanced scorecard represents a major shift in corporate performance measurement. Rather than treating financial indicators as the sole measure of performance, companies recognize that they are only one measure among a broader set. Keeping score of operating measures and traditional financial measures gives management a “balanced” view of the organization.

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