ACC 550 Module 3 Milestone One Example

One Rate for Every Pound: Evaluating the Costing System at a Composite Pecan Sheller

[Student Name]

Southern New Hampshire University

ACC 550: Cost Accounting

Final Project Milestone One

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

One Rate for Every Pound: Evaluating the Costing System at a Composite Pecan Sheller

Introduction

The cost management project asks whether the pecan sheller's cost information can guide its new strategy: shelling more of its crop, growing branded retail packs and expanding the candy division. This first milestone evaluates the current costing system: how it assigns costs, whether those assignments match how resources are used, which decisions it supports and which it distorts, and what an improved system must do. Later milestones build and test the improvement. Kaplan and Cooper (1998) argue that cost systems should be evaluated against the decisions they inform, not against an abstract standard of accuracy, and this evaluation follows that approach.

The Current System

The company's costs fall into three layers.

Nut cost. In-shell pecans bought from growers, about $2.40 a pound last season, make up most of total cost. One pound of in-shell nuts yields roughly 22 percent halves, 26 percent pieces, 4 percent meal and 48 percent shells and loss.

Shelling cost. Plant operating cost for cracking, separating, grading and drying, about $13 million a year, is incurred jointly for all products until the split into halves, pieces and meal.

Post-shelling overhead. After shelling, products are packed, tested, labeled, stored, ordered and shipped. These costs, about $6.2 million a year, include packaging line labor and changeovers, quality testing and labeling, warehouse handling, order processing and customer service.

Nut and shelling costs are joint costs assigned to the three products, a question examined separately in Module Six. Post-shelling overhead is assigned to all output, about 14.56 million pounds a year, at a single rate of about $0.426 a pound, regardless of product, package or customer.

Testing the Rate Against Resource Use

The single rate assumes every pound uses packaging, testing, warehouse and order resources equally. The operating records say otherwise.

Table 1. Share of Output and of Overhead Activities by Channel

Retail packs are 18 percent of pounds but drive most changeovers and orders, because a single retailer order may include six sizes and flavors in small quantities, each requiring a line changeover and a separate lot test. Bulk cartons, sold by the truckload to bakeries and ice cream makers, require few changeovers and few orders per pound. A rate per pound therefore assigns retail packs far less overhead than they cause and bulk cartons more. Balakrishnan et al. (2012) explain why: averaging by volume misleads most when products differ in the batch and customer activities they demand, and Table 1 shows exactly that difference.

Decisions the System Now Distorts

Three decisions depend on post-shelling cost. The first is retail pricing: the company set its 8-ounce pack price to cover the rate-based cost plus a margin, so if the true cost is higher, the margin is smaller or negative. The second is evaluating the candy division, which buys halves in small lots and appears profitable partly because its packaging and testing costs are averaged with bulk volume. The third is choosing which retail chains to serve, since small chains with frequent, mixed orders look as profitable per pound as large ones under the current system. When most of the business was bulk, these errors did not matter; with retail growing, they now drive strategy.

Criteria for an Improved System

An improved system should meet five criteria. It should assign post-shelling overhead by the activities that cause it, at least for changeovers, testing, orders and handling. It should report cost by channel and by customer, not only by product. It should use drivers the company already records, so it can be updated without a new data project. It should leave nut and shelling costs to the joint cost method, where activity-based detail adds little, because those costs are incurred before any product or channel exists. And it should be simple enough for the plant controller to maintain each year. Labro (2019) observes that the benefit of more detailed costing must be weighed against its cost and complexity; these criteria aim at the smallest change that fixes the distortions that matter.

How the Distortion Has Shaped Recent Results

The distortion is not an abstract accuracy problem; it has already shaped decisions. Last year the sales team reported that retail packs earned a margin of about 31 percent after the overhead rate, higher than bulk cartons, and recommended expanding into two more grocery chains. If retail packs actually consume three to four times the overhead per pound that the rate assigns, as the activity shares suggest, their margin is far lower and the two new chains, both with small, frequent orders, may lose money. The candy division's reported profit is similarly flattered, because it buys halves in small lots that require separate testing and packing but is charged the same rate as a truckload. A preliminary estimate, using the activity shares and the cost of each activity pool, puts retail packs' share of post-shelling overhead at about $3.8 million rather than the $1.1 million the rate assigns. That gap is large enough to change pricing and expansion decisions, which is why the next milestone builds the model properly.

Limitations

The activity shares in Table 1 come from one year of records and the packaging supervisor's estimates of labor by channel, which will need confirmation in Milestone Two. The evaluation does not address nut cost or shelling cost, which are significant but are allocated jointly and require a different analysis.

Conclusion

The sheller's costing system assigns $6.2 million of post-shelling overhead at a single rate per pound, which was adequate when bulk cartons dominated but now significantly undercosts retail packs, which drive most changeovers and orders. The system distorts retail pricing, evaluation of the candy division and customer selection. Milestone Two will build an activity-based model for post-shelling overhead that meets the five criteria set here. It will also test whether the model's results hold up when the activity shares are varied within a reasonable range.

References

Balakrishnan, R., Labro, E., & Sivaramakrishnan, K. (2012). Product costs as decision aids: An analysis of alternative approaches (Part 1). Accounting Horizons, 26(1), 1-20. https://doi.org/10.2308/acch-50086

Kaplan, R. S., & Cooper, R. (1998). Cost and effect: Using integrated cost systems to drive profitability and performance. Harvard Business School Press.

Labro, E. (2019). Costing systems. Foundations and Trends in Accounting, 13(3-4), 267-404. https://doi.org/10.1561/1400000058