Activity Cost Driven and Cost Estimation Cool Mountain lee Cream Company produce

Question

Activity Cost Driven and Cost Estimation Cool Mountain lee Cream Company produces ten varieties of ice cream in large vats, several thousand gallons at a tune. The see cream is distributed to several categories of customers. Some ice cream is packaged in large containers and sold to college and university food services. Some is packaged in half gallon or small containers and sold through wholesale distributors to grocery stores. Finally, some is packaged in a variety of individual servings and sold directly to the public from trucks owned and operated by Cod Mountain Management has always assumed that costs fluctuated with the volume of ice cream, and cost estimating equations have been based on the following cost function: Estimated costs = Fixes! costs + Variable costs per gallon Times Production in gallons Lately, how ever, this equation has not been a very accurate predictor of total costs. At the same tune, management has noticed that the volumes and varieties of ice cream sold through the three distinct distribution channels have fluctuated from month to month. Required What relevant major assumption is inherent in the cost estimating equation currently used by Cod Mountain? Why might Cod Mountain wish to develop a cost estimating equation that recognizes the hierarchy of activity costs? Explain. Develop the general form of a more accurate cost estimating equation for Cod Mountain Clearly label and explain all elements of the equation, and provide specific examples of costs for each element.

Explanation / Answer

a. The relevant major assumption inherent in the cost-estimating equation currently used by Cool Mountain are as follows:-

   Fixed remains fixed at any level of Output. Whether the Output level is increased or decreased, the fixed costs remains unaffected. Variable costs varies with the level of output. As the output is increased the variable costs also increased & vice versa.

   For example:- Fixed costs = $20000 and Variable cost per gallon = $ 5.

At Production of 5000 Gallons & 10000 Gallons, total estmated costs equals to

This is the traditional system of assigning overheads, overheads are first allocated and apportioned to cost centres (Production and support service cost centres) and then allocated to cost objects (example products).

b. Cool mountain wish to develop a cost-estimating equation that recognizes the hierarchy of activity costs because of follwing reasons:-

   1) Activity cost driver act as a measure of the frequency and intensity of demand placed on activities by cost objects. It is used to assign actvity costs to cost objects.

2) The new cost-estimating equation will help to estimate cost of individual product or service more accurately.

3) It will help to formulate appropriate marketing/corporate strategy.

4) It will determine what drives the activities of the organization and how these activities can be improved to increase the profitability.

Productions (In gallons) Estimated costs = Fixed costs + Variable costs per gallon * Production in gallons 5000 20000 + 5 * 5000 = 45000 10000 20000 + 5 * 10000 = 70000

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