Lokyer Valley Cooperative (LVC) operates at capacity and processes potatoes into potato cuts at its automated
Plant. It sells potatoes to the retail consumer market and to the institutional market which inclused hospitals,
Cafeterias and universities' dormitories.
LVC's simple costing system has a single direct cost category (direct materials, which are the raw potatoes)
And a single indirect cost pool (production support). Support costs are allocated on the basis of kilograms of
Potato cuts processed. Support costs include packaging materials. The 2009 total actual costs for producing
1,000,000 kilograms of potato cuts (900,000 for the retail market and 100,000 for the institutional market)
Direct material used $150,000
Production support $983,000
The simple costing system does not distinguish between potato cuts produced for the retail and the institutional
Markets.
At the end of 2009, LVC unsuccessfully bid for a large institutional contract. Its bid was reported to be 30%
Above the winning bid. This feedback came as shock because LVC included only its minimum profit margin
In its bid. Moreover, its plant was acknowledged as being the most efficient in the industry.
As a result of its review process of the lost contract bid, LVC decided to explore ways to refine its costing
System. First, it identified that $188,000 of the $983,000 pertaining in packaging materials could be traced to
Individual jobs ($180,000 for retail and $8,000 for institutional). These costs will now be classified as direct
Materials. The $150,000 of direct materials used was classified as $135,000 for retail and $15,000 for
Institutional. Second, it used activity-based costing methods (ABC) to examine how the two products (retail
And institutional potato cuts) used indirect support costs. The finding was that three activities areas could be
Distinguished.
Cleaning activity area - LVC uses 1,200,000 kilograms of raw potatoes to yield 1,000,000
Kilograms of potato cuts. The cost allocation base is kilograms of raw potatoes cleaned. Costs in
The cleaning activity area are $120,000.
Cutting activity area - LVC processes raw potatoes for the retail market independently of those
Processes for the institutional market. The production line produces (a) 250 kilograms of retail
Potato cuts per cutting hour and (b) 400 kilograms for the institutional cuts per cutting hour. The
Cost allocation base is cutting hours on the production line. Costs in the cutting costs are $231,000.
Packaging activity area -LVC packages potato cuts for the retail market independently of those
Packaged for the institutional market. The packaging line packages are (a) 25 kilograms of retail
Cuts per packaging hour and (b) 100 kilograms of institutional potato cuts per packaging hour. The
Cost allocation base is packaging hours on the production line. Costs in the packaging activity area
Are $444,000.
Course Profile for: ACCT19060, 2010 Term Three - Page 7
Required: (Show all workings)
1. Using the simple costing system, what is the cost per kilogram of potato cuts produced by LVC?
2. Calculate the cost rate per unit of the cost driver in (a) cleaning, (b) cutting and (c) packaging activity
Areas.
3. Suppose LVC uses information from its activity cost rates to calculate costs incurred on the retail
Potato cuts and institutional potato cuts. Using the ABC system, what is the cost per kilograms of (a)
Retail potato cuts and (b) institutional potato cuts?
4. Comment on the differences between the two costing systems in 1 and 3 above. How might LVC use
The information in requirement 3 to make better decisions?
5. Explain if Lockyer Valley should have been able to win the bid if it had tendered based on the ABC
Costing method, assuming its profit margin was 10% for the bid.