Forest Hill Report Final Draft Essay

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Forest Hill Paper Company

Activity-Based Costing Analysis

Report

Prepared by:
Martin Hogan
Ty Headly
Berenise Flores
Trevor Hohbein
Group 2
Jina Morris
Acct. 308 Sec. 152

On:
October 31, 2014Executive Summary

Based on our analysis of the current accounting system, it is evident that the current system is not allocating costs appropriately for production. Only grades A and C need slitting, and currently those costs associated with slitting are being allocated for every grade. All profits related to each grade are being misrepresented because of the current way slitting costs are being allocated. Grade A and C are over stating profits, and B and D are understating profits by adding the slitting costs to them. Out of all the grades, grade D makes the most money at $926,005.50. Grade B is currently losing money at a -$4,624.40. Grade A makes $44,904 dollars and grade C makes $30,399.95. Additionally, change-over costs have a great impact on profitability. Change-over costs, which are at a fixed rate of $11,750 per product affect grade B the most because it has the least amount of batches. Since grade B has only two batches the fixed costs are heavily allocated to each of them, making it the least profitable. On the other hand grade D has 175 batches making the amount of the fixed change-over costs lower per batch. That is why grade D is making the most profits.

Volume-based Costing versus ABC

We know our findings to be true based on the analysis we conducted, which will be discussed in this section. First, we proved that the overhead rate under the current system is actually 105 percent of the material cost. We did this by multiplying material cost per reel by average reels per batch for each product and summing the four to determine a total material cost of $1,741,400. Total overhead costs of $1,828,470 were provided in Exhibit 2, and we simply divided total overhead cost by total material cost to determine a rate of 105 percent (see Appendix).

Next, we determined the total volume-based cost of each reel. We found this by adding the material cost per reel and the overhead cost per reel.

Product
Material Cost per Reel
Volume-Based Overhead Cost per Reel
Volume-Based Total Cost per Reel
A
$4,800.00
$5,040.00
$9,840.00
B
$5,200.00
$5,460.00
$10,660.00
C
$5,600.00
$5,880.00
$11,480.00
D
$7,400.00
$7,770.00
$15,170.00

Total grade change costs are $47,000 and total slitting costs are $195,000. Under volume-based costing, these two costs are included in total overhead. We want to separate these from overhead, so we determined the grade change cost per reel and the slitting cost per reel. For slitting cost per reel, we took total slitting costs of $195,000 and divided it by 85, the total number of reels that use slitting. This gave us a slitting cost per reel of $2,294.12. To determine grade change cost per reel, we first divided total grade change costs of $47,000 by 4, the number of different products. This gave us a grade change cost per batch of $11,750. Then, for each product, we divided grade change cost per batch by number of reels per product to determine the grade change cost per reel for each product. Now, by separating grade change costs and slitting costs from overhead, the total overhead costs decreased from $1,828,470 to $1,586,470. This results in a new overhead rate of 91.1 percent of material cost versus the previous rate of 105 percent.

By utilizing this new strategy of activity-based costing, we found the following total costs per reel and variances in costing methods.

Product
Material Cost per Reel
Overhead Cost per Reel
Grade Change Cost per Reel
Slitting Cost per Reel
Activity-Based Total Cost per Reel
A
$4,800.00
$4,372.80
$235.00
$2,294.12
$11,701.92
B
$5,200.00
$4,737.20
$5,875.00
$0.00
$15,812.20
C
$5,600.00
$5,101.60
$335.71
$2,294.12
$13,331.43
D
$7,400.00
$6,741.40
$67.14
$0.00
$14,208.54

Product
Volume-Based Total Cost per Reel
Activity-Based Total Cost per Reel
Change in
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