Case Analysis
on
Sharp Paper Inc.
(Case #3- Activity-Based Costing)
Presented to the Faculty of the
Ramon V. del Rosario College of Business
Management and Organization Department
De La Salle University-Manila
In Partial Fulfilment
Of the course requirements
In ACC535M - GTD
Submitted by:
Acuna, John Paul
Puno, Ivy Claudette
Punzalan, Johanna Margarita
Tayag, Irish June
I. SYNTHESIS
A. Introduction
Sharp Paper Inc. has three paper mills, one of which is located in Memphis,
Tennessee. The Memphis mill produces 300 different types of coated and uncoated
specialty printing papers. Management was convinced that the value of the large variety
of products more than offset the extra costs of the increased complexity.
During 2013, the Memphis mill produced 120,000 tons of coated paper and
80,000 tons of uncoated paper. Of the 200,000 tons produced, 180,000 were sold. Sixty
products account for 80% of the tons sold. Thus, 240 products are classified as low-
volume products.
Lightweight lime hopsack in cartons (LLHC) is one of the low-volume products.
LLHC is
produced in rolls, converted into sheets of paper, and then sold in cartons. In 2013 the
cost to produce and sell one ton of LLHC was $1, 695.
Overhead is applied by using a two-stage process. First, overhead is allocated to
the paper and finishing machines by using the direct method of allocation with carefully
selected cost drivers. Second, the overhead assigned to each machine is divided by the
budgeted tons of output. These rates are then multiplied by the number of pounds
required to produce one good ton.
In 2013, LLHC sold for $2,400 per ton, making it one of the most profitable
products. A
similar examination of some of the other low-volume products revealed that they also
had very
respectable profit margins. Unfortunately, the performance of the high volume products
was less
impressive, with many showing losses or very low-profit margins. This situation led
Ryan Chesser to call a meeting with his marketing vice president, Jennifer Woodruff,
and his controller, Kaylin Penn.
B. Case Facts
TYPE OF PAPER PRODUCED SOLD
COATED PAPER 120,000
UNCOATED PAPER 80,000
TOTAL 200,000 180,000
SELLING PRICE $ 2,400/ton
DIRECT MATERIALS:
FURNISH 2225 lbs $ 450
ADDITIVES 200 lbs 500
TUB SIZE 75 lbs 10
RECYCLED SCRAP PAPER 296 lbs (20)
TOTAL DM $ 940
DIRECT LABOR $ 450
OVERHEAD
PAPER MACHINE $ 100/ton * 2,500 lbs $ 125
FINISHING MACHINE $ 120/ton * 2,500 lbs 150
TOTAL OH $ 275
SHIPPING AND WAREHOUSING $ 30
TOTAL MFG & SELLING COST $ 1,695
● High-volume products are shipped directly to customers while low-volume
products are shipped to distribution centers.
II. POINT OF VIEW
Our team is taking the point of view of Ryan, the CEO of Sharp Paper Inc.
III. PROBLEM STATEMENT
What can Ryan do to properly strategize and respond better to competitive
conditions?
IV. OBJECTIVES
1. To identify the flaws associated with the current method of assigning shipping
and warehousing costs to Sharp’s products which cause cost distortion
2. To decide whether to or not to implement a new cost assignment method
3. To scrutinize and evaluate a product’s profitability and viability using a more
reliable and accurate accounting system
4. To devise a strategy to improve the profitability of the Company’s products and
create and maintain a competitive advantage
V. AREAS OF CONSIDERATION
A. ANALYSIS
● Stakeholders
1. The Company as a whole
2. Department heads
3. Consumers
● Conceptual and Computational Analysis
1. Limitations of the current method of assigning overhead costs
Shipping and warehousing costs are currently assigned using tons
of paper produced. This is an example of a plantwide or departmental rate
which can produce average costs that severely understate or overstate
individual product costs as most of the overhead costs such as shipping
and warehousing are not driven by just one unit of measure, in this case,
the tons of paper. Any company with two or more product lines attempt to
define the accurate cost and would not be satisfied with just an averaging
approach. Proper pricing of a company’s various products would be
impossible without accurate costing.
2. New Method of Assigning Costs: Activity-Based Costing
From the weighted average method of assigning costs using tons of
paper produced, the new method would assign costs using three cost
assignments, namely, receiving, shipping, and carrying which will have
their cost drivers of tons of paper produced, items shipped, and tons of
paper sold respectively.
Activities/ Cost Cost Driver
Assignment
Receiving tons of paper produced
Shipping items shipped
Carrying tons of paper sold
Receiving costs per ton produced:
Receiving costs $ 1,100,000.00
÷ Tons Produced 56,000.00
Receiving costs per ton produced: $ 19.64
Shipping Cost per items shipped:
Shipping costs $ 2,300,000.00
÷ Items Shipped 190,000.00
Shipping Cost per items shipped $ 12.11
Carrying Cost (Opportunity Cost) per Ton Sold:
Carrying cost per year (25 tons * $1,665 * $ 6,660.00
16%)
÷ Tons Sold 10.00
Carrying Cost per Ton Sold $ 666.00
Shipping and Warehousing cost per ton
sold:
Receiving costs $ 19.64
Shipping costs ($12.11 * 7 shipments per 84.77
ton)
Carrying costs 666.00
Total $ 770.41
3. Profit Analysis of LLHC
Revised profit per ton (LLHC):
Selling price $ 2,400.00
Less manufacturing cost 1,665.00
Gross profit $ 735.00
Less shipping and warehousing 770.41
Loss $ (35.41)
Original profit per ton:
Selling price $ 2,400.00
Less manufacturing cost 1,665.00
Gross profit $ 735.00
Less shipping and warehousing 30.00
Profit $ 705.00
4. SWOT Analysis
Strengths Weaknesses
- The ability of the management to - The use of the current accounting
define activities and their system or costing approach which
equivalent cost drivers (Read the distorts product costs
3rd statement of Jennifer)
- Their inclination to do the same
- Leveraging idea generation to thing as other companies do
engender solutions for the regardless of its compatibility or
cost/profitability issue before applicability to the company's own
arriving at a decision for beliefs, processes or product
implementation (If Ryan did not variation (i.e. "bandwagon effect")
brainstorm or consult with Jennifer
and Kaylin, his decision would be
erroneous)
- Kaylin’s identification of opportunity
cost (cost of carrying inventory)
which should also be properly
assigned (Read the last statement
of Kaylin)
Opportunities Threats
- The application of a new costing - It will not show the true financial
approach (i.e. Activity Based performance or profitability of its
Costing) which properly assigns products.
costs to activities and therefore
reflects the true financial - if the company does not adopt a
performance or profitability of its new system, a possible erroneous
products. ABC brings accuracy decision will be made due to
and reliability in product cost inaccurate or unreliable data which
determination by focusing on will be deterrent to achieving
cause and effect relationship in the success and financial objectives
cost incurrence.
- It will give the management the
- ABC produces reliable and correct impression that all its products are
product cost data in case of performing overall, were in fact,
greater diversity among the some of its products need to be
products manufactured such as improved/be discontinued
low-volume products, high-volume
products and therefore improves - Will not be able to maximize its
greatly the management decision productivity
making. Applying it provides a
chance to reevaluate products and
devise a strategy to improve
product viability and profitability via
minimization of costs or
maximization of revenue (i.e.
increasing selling price and
decreasing carrying cost)
- Proper costing provides an
opportunity to re-calibrate their
products particularly the high-
volume and make it more cost
competitive or cheap compared to
other similar products
- Applying ABC can lead to the
identification of idle capacity and
the promotion of cost reduction
which then, provides a platform for
the emergence of activity-based
budgeting in where future resource
requirements can be
projected/forecasted
B. ASSUMPTIONS
1. There is great diversity among the products manufactured (low-volume products
and high-volume products)
2. The company’s current costing system uses arbitrary apportionment/distribution
and absorption method.
3. The company and the industry where it belongs is within a competitive market.
Thus, any decision made and strategies applied (e.g. a shift of marketing focus,
keeping or dropping a product line etc.) will greatly affect the standing of the
company.
VI. ALTERNATIVE COURSE OF ACTION
A. Courses of Action
1. Status quo
Ryan will continue to adapt the current cost assignment approach where shipping
and warehousing are assigned to products using tons produced at $30-per-ton.
Pros:
a. Information is readily available
b. The approach is easy and convenient to implement
c. This method to assign these costs is identical to a number of other
paper companies.
d. Saves time and effort as there will be no change in the current
accounting system
Cons:
a. Some overhead cost may not bear any relationship with tons
produced.
b. Assumes that products are similar in volume, complexity, batch size
and therefore distorts product costs
c. Due to distorted costs, profitability analysis of products can be
erroneous
d. Due to erroneous profitability analysis, the company might suffer
more losses upon deciding to drop some high-volume products and
emphasize in marketing strategies the low volume products
2. Restructure the accounting system
Ryan will totally scrap out the current method and adopt a new cost assignment
approach where activity cost pools are identified including the related cost drivers
Pros:
a. More accurate overhead cost allocation
b. More effective overhead cost control and assist on better
management of activities. (e.g. deciding whether to shift marketing
focus, dropping a product line)
c. Focus on relevant factors and can assist in distinguishing value-
added activities
Cons:
a. Costly to implement and maintain as it entails remodeling and
overhauling the accounting system
b. Possible resistance from affected parties
c. Uncertainty with decisions still remains
d. Fails to meet financial reporting requirements (GAAP)
3. Improve the accounting system to incorporate activity-based costing that will aid
the management reporting and decision-making
Ryan will retain the current method for financial reporting purposes and adapt the
activity-based costing for internal or management reporting to improve the
accuracy of assigning overhead costs (i.e. shipping and warehousing costs) to
Sharp’s products (i.e. low-volume and high-volume products)
Pros:
a. Will not involve restructuring the whole system as it would only add
up a feature
b. Provides more accurate overhead cost allocation and improves
profitability analysis and decision-making while still meeting the
financial reporting requirements (GAAP)
c. More effective overhead cost control and assist on better
management of activities. (e.g. deciding whether to shift marketing
focus, dropping a product line)
Cons:
a. Still costly to implement and maintain
b. Uncertainty with decisions still remains
B. Decision Criteria
Criteria Weight ACA ACA ACA
1 2 3
Process Improvement 15% 5% 15% 15%
Cost Accuracy 30% 5% 30% 30%
Ease of 15% 15% 5% 10%
Implementation
Cost- Benefit 40% 10% 20% 35%
TOTAL 100% 35% 70% 90%
VII. RECOMMENDATION
Our team recommends ACA 3 which is to retain the current method for financial
reporting purposes and adapt the activity-based costing for management reporting
because doing so will provide information that supports better management of
company resources in goods production and improves competitiveness in relation
to costs, quality, and profitability without veering away from external financial
reporting requirements
VIII. IMPLEMENTATION PLAN
A. METHODS/ACTION STEPS
a. Applying Activity-Based Costing
1. Identify the activities and the costs they cause.
2. Group similar activities into activity cost pools
3. Determine an activity rate for each activity cost pool
4. Allocate overhead costs to products using those activity rates.
b. With the revised calculation of costs, review the profitability of each
product
c. Increase selling price of low-volume products and reduce the selling
price of high- volume products while considering industry standard and
market impact
d. Review the market performance of products
e. Apply relevant costing in deciding to drop or continue a product line
B. TIMELINE
A few months depending on the number of identified activities or cost pools and
the availability of needed financial and non-financial data
IX. LEARNING POINTS
● Hasty or impulsive decisions without thoroughly understanding the facts and
without reflective thought could lead to potential consequences and dangers not
only in financial matters but also to relationships and other matters
● Garbage in, Garbage out. Incorrect or poor quality input will always produce
flawed or inaccurate output. In this case, distorted costs produced erroneous
profitability analysis which leads to unsound decisions.
● There will be trade-offs in deciding between alternatives. Costs and benefits
should be properly weighed to arrive at a sound decision and perform a
reasonable action.
● The use of activity-based costing for multiple products of a company will give
management more reliable information than average/weighted average method.
References:
http://www.yourarticlelibrary.com/accounting/costing/advantages-and-demerits-of-
activity-based-costing-abc/52617
https://www.researchgate.net/publication/228301164_Activity-
Based_Costing_System_Advantages_and_Disadvantages
https://quickbooks.intuit.com/r/pricing-strategy/activity-based-vs-traditional-costing/
