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P4-4A Memo - get allocated to the complex product since its...

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Memo DATE: February 29, 2008 TO: Tyler Silva, President FROM: RE: Implication Analysis I understand your concern in regard to the company’s suggestion of discontinuing the productio n of CoolDay. In an attempt to clarify the information contained in the analysis let me explain the implication analysis of the cost per liter using the traditional costing approach and using activity-based costing. In ABC costing, the overhead is allocated based on the use of the cost drivers. A product using more of the resources would get a higher allocation of cost. In the ABC system the costs allocated are more in line with the use of resources and therefore are better allocated than in traditional costing systems. Traditional costing systems usually allocate costs based on a single base such as direct labor. This results in simple products with high volumes getting a higher share of the overhead costs. Even though a complex product may increase costs, the costs do not
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Unformatted text preview: get allocated to the complex product, since its use of direct labor may be less. The actual usage of resources has no relation to the direct labor. In this case, when the company started producing LiteMist, the overhead costs increased significantly since LiteMist required complex procedures, it being sold in 1-liter bottles. Since the allocation base was direct labor, CoolDay as apportioned a higher proportion of costs and therefore the profitability of CoolDay declined. As can be seen, the traditional approach gave the cost of CoolDay as $1.078 where it came to $0.891 in ABC costing. It is my opinion the company should rethink its plans of stopping the production of CoolDay. Memo I hope that you find the above explanation satisfactory in regard to the information provided in the analysis. Contact me should you have any other questions or concerns. Thank you....
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