Ace Fertilizer Case Study 2x1fa
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Case Summary: In this case study, Ace Fertilizer’s Assistant Director of Manufacturing, Abby Conroy, is faced with an ethical dilemma presented by her direct manager George Smilee, Director of Manufacturing. Ace Fertilizer’s Principal business is production of lawn & gardening fertilizer, however the company has a proven record of delivering high quality, on-time products in the special orders market. It’s the quality and on-time production that drives this area of the business. They use a consistent billing formula for special orders at an 80% markup over the cost of the orders. Abby Conroy prefers allocating indirect costs using Activity-Based Costing for these orders, recognizing that not all costs are driven by volume of output. Abby is preparing a cost estimate for Breeland Ltd., a company that has requested a special order for a solvent whose ingredients include 40 gallons of a chemical called XO-1600. The chemical XO-1600 is only available in 50-gallon drums and has a shelf-life of only 20 days once opened. After 20 days, the substance becomes unstable and must be discarded properly. Breeland Ltd. does not wish to keep the unused gallons. The following is her cost estimate: Direct Materials Non-XO-1600
$20,000
XO-1600 Purchase Cost
$80,000
Disposal Cost Direct Labor
$10,000 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+80,000+10,000+30,000+160,000+20,000)
$320,000
Total Cost of Breeland Ltd Special Order
$750,000
Markup on cost ($750000/.80)
$900,000
Total Price Determination for Breeland Ltd. order
$1,650,000
Since Breeland Ltd only needs 40 gallons of XO-1600, they do not wish to keep the unused gallons and no other orders are confirmed that uses this substance, Ace’s estimate includes a $10,000 disposal cost for the remainder. At a family weekend get-together, George Smilee makes an unconfirmed deal with his brother Josh to purchase the unused gallons of XO-1600 for Josh’s company. In consideration of this, Abby wants to ask Breeland Ltd for more time to deliver the
estimate, so that she can rework the cost allocations to reflect the appropriate billing for only what Breeland Ltd’s order will be using. George asks her not to do this, citing the ability to bill the 10 gallons of XO-1600 to Breeland Ltd. and Josh’s company. The $10,000 disposal cost would not be incurred by Ace, however it would remain on the estimate for Breeland Ltd. This would add $93,600 (with markup) to Ace’s bottom line, helping to meet their monthly profit goal.
Question 1. Did Abby compute the cost of the Breeland Ltd. special order correctly before the weekend get-together? If not, how was her cost estimate and/or price determination flawed? Answer: Abby’s cost estimate was flawed due to an error in the markup figure. Rather than multiplying the total costs for the order by .80, she divided by .80. The cost estimate with correct markup should be: Direct Materials Non-XO-1600
$20,000
XO-1600 Purchase Cost
$80,000
Disposal Cost Direct Labor
$10,000 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+80,000+10,000+30,000+160,000+20,000)
$320,000
Total Cost of Breeland Ltd Special Order
$750,000
Markup on cost ($750000*.80)
$600,000
Total Price Determination for Breeland Ltd. order
$1,350,000
Question 2. Whose assessment of the costing of this special order do you believe is correct – George Smilee’s or Abby Conroy’s? That is, should George’s conversations with Josh impact Abby’s cost estimate of the Breeland Ltd. special order? Answer: Provided the correction is made to the markup, Abby’s assessment would be the correct estimate. In accordance with company policy, Abby includes billing the full cost of the order’s materials, assuming there will be unused portions. However, once there is an order for remaining unused materials, disposal is no longer a cost to Ace Fertilizer, and
therefore does not need to be ed on to the customer. Furthermore, the cost of the XO-1600 itself can be allocated accordingly between the two cost estimates. George’s assessment includes double billing for a single material cost, as well as a disposal fee, which is not needed, in order to inflate the bottom line. Question 3. Are there any ethical issues related to the cost determination on the Breeland Ltd. special order? If so, what issues are present? How should Abby resolve these conflicts? Should Abby go directly to Tom Brennen about this new development? How can Abby use the IMA Statement of Ethical Professional Practice as a guide for her actions? Answer: The ethical issues are, as stated above, double billing for a single cost and not removing unnecessary costs (disposal) from an estimate in order to inflate profits. It may also be conflicting interests to do so when one customer is family of the Director of Manufacturing. Abby’s decision to revise the order is the ethical approach. According to the IMA guide, Abby should the next higher-up, Tom Brennen. Since Tom is the Chief Operating Officer and ultimately has to sign off on orders before they are finalized, he should be made aware of the pending order for the remaining XO-1600. Question 4. If Abby were to modify her original cost estimate of the Breeland Ltd. special order to include Josh’s purchase of the remaining 10 gallons of XO-1600, what price determination would she have arrived at? What impact would that have had on Ace Fertilizer’s bottom line? Answer: The following is a revised cost estimate: Direct Materials Non-XO-1600
$20,000
XO-1600 Purchase Cost (80,000 * 40/50)
$64,000
Disposal Cost Direct Labor
$0 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+64,000+10,000+30,000+160,000+20,000)
$294,000
Total Cost of Breeland Ltd Special Order
$698,000
Markup on cost ($698000*.80)
$558,400
Total Price Determination for Breeland Ltd. order
$1,256,400
Total of Abby's Original Cost Estimate: Total adjusted cost estimate Difference
$1,650,000 $1,256,400 $393,600
Total of corrected original cost estimate: Total adjusted cost estimate Difference
$1,350,000 $1,256,400 $93,600
Ace Fertilizer’s bottom line is reduced with the modified estimate, however it reflects a professional and ethical price determination, making their products more valuable to current and future customers. This strengthens the integrity of their operation. In conclusion, it may serve Ace Fertilizer Company well to implement a second person to approve final orders for purposes of greater internal controls. I would also review the company’s definition of “conflict of interests” to ensure favors are not given to certain orders at the expense of other customers.
$20,000
XO-1600 Purchase Cost
$80,000
Disposal Cost Direct Labor
$10,000 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+80,000+10,000+30,000+160,000+20,000)
$320,000
Total Cost of Breeland Ltd Special Order
$750,000
Markup on cost ($750000/.80)
$900,000
Total Price Determination for Breeland Ltd. order
$1,650,000
Since Breeland Ltd only needs 40 gallons of XO-1600, they do not wish to keep the unused gallons and no other orders are confirmed that uses this substance, Ace’s estimate includes a $10,000 disposal cost for the remainder. At a family weekend get-together, George Smilee makes an unconfirmed deal with his brother Josh to purchase the unused gallons of XO-1600 for Josh’s company. In consideration of this, Abby wants to ask Breeland Ltd for more time to deliver the
estimate, so that she can rework the cost allocations to reflect the appropriate billing for only what Breeland Ltd’s order will be using. George asks her not to do this, citing the ability to bill the 10 gallons of XO-1600 to Breeland Ltd. and Josh’s company. The $10,000 disposal cost would not be incurred by Ace, however it would remain on the estimate for Breeland Ltd. This would add $93,600 (with markup) to Ace’s bottom line, helping to meet their monthly profit goal.
Question 1. Did Abby compute the cost of the Breeland Ltd. special order correctly before the weekend get-together? If not, how was her cost estimate and/or price determination flawed? Answer: Abby’s cost estimate was flawed due to an error in the markup figure. Rather than multiplying the total costs for the order by .80, she divided by .80. The cost estimate with correct markup should be: Direct Materials Non-XO-1600
$20,000
XO-1600 Purchase Cost
$80,000
Disposal Cost Direct Labor
$10,000 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+80,000+10,000+30,000+160,000+20,000)
$320,000
Total Cost of Breeland Ltd Special Order
$750,000
Markup on cost ($750000*.80)
$600,000
Total Price Determination for Breeland Ltd. order
$1,350,000
Question 2. Whose assessment of the costing of this special order do you believe is correct – George Smilee’s or Abby Conroy’s? That is, should George’s conversations with Josh impact Abby’s cost estimate of the Breeland Ltd. special order? Answer: Provided the correction is made to the markup, Abby’s assessment would be the correct estimate. In accordance with company policy, Abby includes billing the full cost of the order’s materials, assuming there will be unused portions. However, once there is an order for remaining unused materials, disposal is no longer a cost to Ace Fertilizer, and
therefore does not need to be ed on to the customer. Furthermore, the cost of the XO-1600 itself can be allocated accordingly between the two cost estimates. George’s assessment includes double billing for a single material cost, as well as a disposal fee, which is not needed, in order to inflate the bottom line. Question 3. Are there any ethical issues related to the cost determination on the Breeland Ltd. special order? If so, what issues are present? How should Abby resolve these conflicts? Should Abby go directly to Tom Brennen about this new development? How can Abby use the IMA Statement of Ethical Professional Practice as a guide for her actions? Answer: The ethical issues are, as stated above, double billing for a single cost and not removing unnecessary costs (disposal) from an estimate in order to inflate profits. It may also be conflicting interests to do so when one customer is family of the Director of Manufacturing. Abby’s decision to revise the order is the ethical approach. According to the IMA guide, Abby should the next higher-up, Tom Brennen. Since Tom is the Chief Operating Officer and ultimately has to sign off on orders before they are finalized, he should be made aware of the pending order for the remaining XO-1600. Question 4. If Abby were to modify her original cost estimate of the Breeland Ltd. special order to include Josh’s purchase of the remaining 10 gallons of XO-1600, what price determination would she have arrived at? What impact would that have had on Ace Fertilizer’s bottom line? Answer: The following is a revised cost estimate: Direct Materials Non-XO-1600
$20,000
XO-1600 Purchase Cost (80,000 * 40/50)
$64,000
Disposal Cost Direct Labor
$0 $30,000
Unit-level Activity Cost ($40 * 4,000 gallons)
$160,000
Batch-level Activity Cost ($5000 * 4 batches)
$20,000
Product-level Activity Cost
$80,000
Customer-level Activity Cost
$30,000
Organization-sustaining level Activity cost (20,000+64,000+10,000+30,000+160,000+20,000)
$294,000
Total Cost of Breeland Ltd Special Order
$698,000
Markup on cost ($698000*.80)
$558,400
Total Price Determination for Breeland Ltd. order
$1,256,400
Total of Abby's Original Cost Estimate: Total adjusted cost estimate Difference
$1,650,000 $1,256,400 $393,600
Total of corrected original cost estimate: Total adjusted cost estimate Difference
$1,350,000 $1,256,400 $93,600
Ace Fertilizer’s bottom line is reduced with the modified estimate, however it reflects a professional and ethical price determination, making their products more valuable to current and future customers. This strengthens the integrity of their operation. In conclusion, it may serve Ace Fertilizer Company well to implement a second person to approve final orders for purposes of greater internal controls. I would also review the company’s definition of “conflict of interests” to ensure favors are not given to certain orders at the expense of other customers.
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