Case 2A-6 Activity Based Absorption Costing and Pricing

Java Source (JSI) buys coffee beans from around the world and roasts, blends and packages them
for resale. JSI prices its coffees at manufacturing costs plus a markup of 25%. Next year’s budget
includes estimated manufacturing overhead cost of $2,200,000 and JSI assigns manufacturing overhead
to products on the basis of direct labor hours. The expected direct labor cost totals $60,000 for 50,000
hours of direct labor time.

Expected costs for direct materials and direct labor for one-pound bags of two of JSI’s coffee products

Kenya Dark Viet Select

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Direct Materials …................................... $4.50 $2.90

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Direct Labor (0.2 hours per bag) ….......... $0.34 $0.34

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Expected Manufacturing Overhead Costs
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Expected Production of Kenya Dark and Viet Select Coffee

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 Kenya Dark Viet Select

# of Purchase 80,000lbs expected sales/20,000 4,000lbs/500 minimum order =

Orders…................................ minimum order = 4 orders 8 orders
# of 80,000lbs expected sales/5,000 4,000lbs/500 batch size = 8
Batches….................................... batch size = 16 batches batches
.........
# of 80,000lbs expected sales/5,000 4,000lbs expected sales/500
Setups…...................................... batch size = 16 batches(2 setups batch size = 8 batches(2 set ups
........ per batch) = 32 setups per batch) = 16 setups
# of Roasting 80,000lbs expected sales(1.5 4,000lbs expected sales(1.5
Hours…................................. roasting time)/100lbs = 1,200 roasting time)/100lbs = 60
hours hours
# of Blending 80,000 lbs expected sales(0.5 4,000lbs expected sales(0.5
Time…................................... blending time)/100lbs = 400 blending time)/100lbs = 20
hours hours

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# of Packaging 80,000lbs expected sales(0.3 4,000lbs expected sales(0.3

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Time…................................ packaging time)/100lbs = 240 packaging time)/100lbs = 12

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hours hours

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1. Using direct labor-hours as the manufacturing overhead cost allocation base, do the following:
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a. Determine the plantwide predetermined overhead rate that will be used during the year.

POHR = $2,200,000 estimated total manufacturing overhead

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50,000 direct labor hours

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POHR = $44 per direct labor hour

b. Determine the unit product cost of one pound of Kenya Dark coffee and one pound of
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Viet Select coffee.

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Kenyon Bank Viet Select

Unit Product Cost per $2,200,000 MOH/80,000lbs = $2,200,000 MOH/4,000lbs =
Pound…................... $27.50 per pound $550 per pound
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2. Using the activity-based absorption costing approach, do the following:

a. Determine the total amount of manufacturing overhead cost assigned to Kenya Dark
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coffee and to Viet Select coffee for the year.

Kenyon Bank Viet Select

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 Purchasing…................................... $280 per order(4 orders) = $1120 $280(8 orders) = $2240
Material Handling…......................... $193 per order(32 setups) = $6176 $193(16 setups) = $3,088
Quality Control…............................. $90,000/500 = $180 per batch $90,000/500 = $180 per batch
$180 per batch(16 batches) = $180 per batch(8 batches) =
$2880 $1440
Roasting…........................................ $11(1200 hours) = $13200 $11(60 hours) = $660
Blending…....................................... $6(400 hours) = $2400 $6(20 hours) = $120
Packaging…..................................... $5(240 hours) = $1200 $5(12 hours) = $60
Total Manufacturing Overhead Cost.. $26,976 $7,608

b. Using the data developed in (2a) above, compute the amount of manufacturing
overhead cost per pound of Kenya Dark coffee and Viet Select coffee.

Kenyon Bank Viet Select

Unit Product Cost per $26,976 MOH/80,000lbs = $0.34 $7608 MOH/4,000lbs = $1.90

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Pound…................... per pound per pound

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c. Determine the unit product cost of one pound of Kenya Dark coffee and one pound of
Viet Select coffee.

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Direct $4.50 per one pound $2.90 per one pound
Materials…...................................
Direct Labor (0.02 hours per $0.34 $0.34
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bag)…............
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Manufacturing $0.34 $1.90

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Overhead…........................
Unit Product $5.18 $5.14
Cost…....................................
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3. Write a brief memo to the president of JSI that explains what you found in (1) and (2) above and
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that discusses the implications of using direct labor hours as the only manufacturing overhead
cost allocation base.
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MEMO
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TO: President, JSI

FROM: Jennifer Robinson

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As you can see from my data above, by using direct labor-hours as the only manufacturing overhead
cost allocation base, you are receiving misleading and incorrect cost information.

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