the Juice Company, has been concerned over

Implementation of Activity-based costing (ABC)
The case of a Juice Company

John Orland, controller of the Juice Company, has been concerned over the erosion of the recent financial results especially for the
standard flavors (A and B) which used to earn a hefty 20 per cent of profit margin.
Recently, Dan Brun, the sales manager has expanded the lines of products to encompass new flavors (B & C) which were in high
demand by customers who were willing to pay 5 to 10 % premium.
Richard Dunn, the manufacturing manager, was also excited to introduce the new flavors since they were expected to generate higher
margins while using the same technology as standard flavors. However, he noticed that the introduction of new flavors added some
technical complexities to the production process. For instance, unlike Flavors A & B, which were produced in huge volume and in
long production runs, difficulties started to arise with the new flavors which were produced in smaller batches but required more
changeovers and more production runs (see Exhibit 3).
The Juice Company produced the different flavors in the same factory. Each flavor had a bill of materials that determines the quantity
and cost of direct materials used for the production of each flavor. Additionally, a cost sheet was used to track the direct labor
expenses incurred at each operating step for each of the four flavors. All overhead costs were grouped at the plant level and allocated
to each flavor on the basis of direct labor cost. The rate was set at 400 % of direct labor costs (see Exhibit 2).
John was intrigued by the behavior of their main competitors who were more interested in competing in, what appears according to the
company’s current costing system, to be low profit margin flavors (A and B) than in high profit margins (Flavors C &D). Such
1

behavior has led the controller to question the accuracy of that costing system and to conclude that the current method of allocation of
indirect costs is distorting their product costs thereby causing inappropriate pricing.
To remedy the distortions caused by the traditional method of costing based on one single cost pool of indirect costs, John decided to
implement Activity-based costing (ABC) method which focuses on the activities, how they are performed, and the resources they
consumed and to assign activities costs to products based on how much demand each of these products puts on these activities. After
careful analysis of the company’s operations, the controller identified four main activities: process production run, set up equipment,
manage products, and run machines. The demand on these activities by different flavors is illustrated in Exhibit 3.
He began by identifying the resources that were being consumed by activities. These resources were grouped in six categories as
shown in Exhibit 1.
After interviewing the department heads in charge of support staff wages and benefits and insurance, he found out that their services
are used by three activities: process production run (40%), set up (40%), and the remaining 20 % consumed to manage products.
Next, the controller tackled the information system item and determines, after interview with the head of the information system
department, that process production runs accounts for 30 % of their services while 70 % are used to manage products.
The results of his investigations about the usage of the equipment revealed that it was entirely used to run machines. Maintenance
services were shared equally between the production run activity and run machine activity. Finally, utility was shared equally by the
four activities.

2

Questions
1. Describe the problem the company is facing
2. Calculate the costs for the four favors using ABC
3. Explain why, in this case, the ABC costs are different from those provided by the traditional method based one single cost pool of
indirect costs and provide examples from the case that support your analysis.
4. What are the managerial implications for the revised costs?-what would you do if you were the manager of the company and why?

3

Exhibit 1
Resources Used

Costs of Resources

Support staff wages

$30,000

Benefits and
insurances

12000

Information Systems

8000

Equipment

7000

Maintenance

3000

Utilities

4000

Total

$64,000

4

Exhibit 2:
Traditional
Income
Statement
Sales
Material Costs
Direct Labor
Costs
Overhead
Costs @400%
Total
Operating
Income
Profit Margin

Flavor A
$85,000

Flavor B
$50,000

Flavor C
$16,500

Flavor D
$3,500

Total
$155,000

29000
9000

20000
4750

5000
1750

400
500

54,400
16,000

36000

19000

7000

2000

64,000

$11,000

$6,250

$2,750

$600

$20.600

13%

13%

17%

17%

13%

5

Exhibit 3:Direct
costs and
Activity cost
drivers
Production sales
in units
Sales in Dollars
Unit selling
price
Unit material
cost
Machine hours per
unit
Production runs
Total setup time
(hours)
Manage Products

Flavor A
60000

Flavor B
50000

Flavor C
10000

Flavor D
2000

Total
122000

$85,000
$1.42

$50,000
$1.20

$16,500
$1.65

$3,500
$1.75

$155,000

0.48

0.4

0.5

0.2

0.1

0.1

0.1

0.1

12200

50
200

50
50

38
220

12
45

150
515

1

1

1

1

4

6