University of Toledo, Acct 3320 case study one. Need help.
Dream Chocolate Case
Due date: October 12th, 2016
Kay Johnson sat back in his chair wondering about what he had just done. He accepted a
special order from a national supplier of wellness products for 200,000 chocolate bars at a 20
percent discount from the usual price. It is a new type of bar and the company provided the
recipe. The company also hinted about a second order for 150,000 bars if the first order was
successful. Kay sighed and thought, ??I hope we can make a profit on this order, because we are
going to have to increase our capacity big-time to fill it. Wish I knew what the cost will be.??
OVERVIEW OF COMPANY
Dream Chocolate (D.C.) is the major product line of Salmon River Foods, the spawn of a trip
on the Middle Fork of the Salmon River in Boise, Idaho. President Kay Johnson was burned out
by 30 years in the food service industry and decided to sell his business and begin anew. Quite
by accident, he received a call asking if his new company Salmon River Foods would consider
chocolate bars. Kay?s son Rob was employed by a German company and was frequently flying to
Europe and returning with wonderful chocolate as family gifts. Kay wondered how he could
produce European-style chocolate (no waxes or preservatives) in the U.S. With his son?s help, he
found a supplier in Germany who would ship to the U.S. Kay purchased a chocolate factory in
Boise and began production in April 2002. Kathleen Wasson, Vice President, oversees the
creative arts department and assists Kay in managing the plant.
What started with one basic milk chocolate bar has grown to include two milks, two darks,
two semi-sweets, one white, one bittersweet, and other adaptations involving various ingredients
such as coffee, berries, and fresh mint. The chocolate is wonderful, but the real charm of the
product is its custom labeling. For individual snacking, D.C. bars are sold in specialty markets,
fine gift stores, and other locations. They are also available for corporate events and celebrations,
such as weddings and birthdays.
D.C. is a small company trying to survive in an industry with many players. Competition can
come from the many custom chocolate bar providers on the Internet (e.g., Custom Candy
Creations, Totally Chocolate, Carson Wrapped Hershey?s Chocolates, to name a few), as well as
from big chocolate companies (e.g., Mars, Nestle , and Hershey?s) who can always beat D.C. on
price. As such, it pursues any type of order it can get. The company?s niche is European-style
custom chocolate bars and labeling, and it is known for its flexibility and speed. For instance, a
small customer order can be printed, labeled, and ready for pickup or shipping within an hour if
the company already has the label in its system. Few, if any, of D.C.?s competitors can match this
turnaround time or its combination of high-quality bars, variety of flavors, and custom labeling.
Sales were about $500,000 in 2010. Demand was increasing in August and September 2010,
which are normally weaker months due to fewer special events. This gave D.C. management
1 great hope, but the continued national recession hurt sales in 2011 (as it did for most companies).
When asked about the issues D.C. faced at that time, Kay Johnson said that:
We need more business to utilize our capacity and make a profit. As we do so, the main
issue will be training people. It takes up to three months to train people adequately. Also,
custom labeling needs to be more effectively marketed. This is our best margin area. If
we focused our business on low-margin, high-volume chocolate bars we could be
vulnerable to customers dropping us for another supplier.
It is now 2016 and D.C. is starting to get bigger orders, such as the one for 200,000 bars.
D.C. bars are also now being sold in some REI1 outlets around the country. As is common with
small companies, Salmon River Foods has an inadequate costing system. For example, it is
unable to compute actual costs per order or per bar. For pricing purposes, Kay estimates the costs
of each type of bar using his experience and knowledge of ingredient prices and what he pays out
each month in expenses. Each order is different, and typically ranges from 150 bars to 10,000
bars. It is difficult for the company to estimate an accurate cost for an order for pricing purposes,
so he really never knows whether orders are profitable or not. Kay wondered how to accurately
determine the cost for this new special order?the biggest order in the company?s history by far!
Adding to the challenge are limited resources for more accounting work. D.C. employs an
hourly wage Boise State University accounting graduate part-time to do its monthly bookkeeping
(books are closed at the end of the year). A local CPA does its financial statements, taxes, and
provides occasional advice. However, Kay now needs a new type of costing system to provide
accurate cost estimates, and is wondering what type of costing system makes sense for his small
but growing business.
Making high-quality chocolate bars is a challenging process. The bulk chocolate must be
melted and flavored just right before being tempered, which is a process that aligns the crystals
in molten chocolate to produce the best texture balance of firm and creamy. Kay Johnson
described the challenges in achieving the right formula:
It?s a high-end process. The chocolate is temperamental, and, much like wine, there are
many different kinds, qualities, and layers of flavor. We try to make ours less sugary and
more pure, so that chocolate is the first thing you taste.
D.C. employs a full-time Master Chocolatier, who oversees the entire production process,
fills in at any area when there is a need, and performs most of the product inspections. Exhibit 1
provides a flow chart of the 3,000 square foot factory and the seven production areas, each of
which are discussed next.
1. Receiving Area
As soon as the bulk chocolate is received in the Receiving Area, it is dated and placed in the
1 REI is a national retail chain of outdoor clothing and equipment products (see: www.REI.com).
2 Imported Chocolate Storage area. Organic chocolate, which comes from a U.S. supplier, has a
separate shelf from the rest of the bulk chocolate. 3 2. Pouring Area
After the Pouring Area is cleaned and cleared of all non-organic chocolate (if necessary), the
bulk chocolate is brought to the melting pots to be melted. Any flavors (e.g., mint or lavender
oil) and ingredient additives (e.g., huckleberries or nuts) are added to the pots at the right time.
This process consists of tempering and pouring the chocolate into molds, then moving the molds
to the Cooling Tower. There are separate racks for organic and non-organic bars.
3. Inspection Area
Bars are taken out of the molds on the Chocolate Breakdown Table, and the newly formed
chocolate bars are placed on a rack in the Inspection Area. In the Inspection Area, the Master
Chocolatier weighs the bars and visually inspects each one for flaws. Flawed bars are sent back
to the Chocolate Rework Storage area to be re-melted and used again. There is very little waste
in the process and no by-products.
4. Foiling Area
After the chocolate is inspected, it is sent to the Foiling Area to be manually foiled. After
foiling, the chocolate bars are either sent immediately to the Labeling area to be completed as
??retail stock?? or put on the Foiled Product shelves to be held for future orders as ??bright stock.??
D.C. likes to keep bright stock on hand to be able to quickly fill future orders for the more
common sizes and flavors. Bright stock boxes are dated and used based on first-in first-out
5. Labeling Area
In the Labeling Area, foiled chocolate bars are manually labeled and prepared for shipping.
Some retail stock orders are labeled with standard, pre-designed D.C. labels describing the
flavor, type of chocolate, and possibly a theme (e.g., ??The Wine-Lovers Bar?? or ??Think Pink
Dark Chocolate??). Other orders are for ??Custom Label Bars?? for advertising or special events
(e.g., weddings, store openings). These labels include things like company logos, photos,
paintings, and even resumes and personal business cards. D.C. requires a 150-bar minimum and
charges an additional amount for the custom label design costs, which can vary significantly
depending on customer needs. VP Kathleen Wasson edits the many retail and custom labels
produced for D.C. bars. All labels are printed on D.C.?s color laser printer.
6. Finished Product Storage Area
All labeled bars are stored in the Finished Product Storage Area until shipped or picked up by
customers. The company produces significant varieties of both bright stock and retail stock.
There are approximately 40-plus different flavor and size variations of bright stock in storage.
The retail stock has even more types of bars for different retail clients. 4 7. Shipping Area
The bars are invoiced, packed, and shipped out to the customer FOB shipping point. If
deemed necessary, the bars are packed in insulated material with a cold pack to prevent melting.
D.C. sells many types of bars, with varying sizes, ingredients, and flavors. Although there are
other sizes available, D.C. typically sells bars in three standard sizes: 1.25 oz. (both organic and
non-organic), 3.0 oz. (non-organic only), and 3.25 oz. (organic only). This section describes the
ingredients, labor, and overhead required to make its bars.
Table 1 provides typical prices and costs of chocolate for the standard-sized bars. The bulk
chocolate is generally from German suppliers, but D.C. also has a U.S. supplier of high-quality
chocolate. Chocolate prices can vary, due largely to unstable conditions in major cocoa beanproducing nations such as the Ivory Coast. Standard chocolate bars, with no additional flavors or
special ingredients, comprise about half (47 percent) of total sales. Besides chocolate and other
ingredients, the product cost includes the foil and label. Table 1 provides the typical costs for
these items. Bars can have one or more types of special flavors and ingredient additives, such as the
recent order from the wellness company. The additional costs for these additives are handled in
different ways. Flavor additives are a relatively small part of the overall weight of the bar, and
primarily affect the taste of the chocolate itself. Bars with higher-cost flavor additives, such as
coffee and Kava, comprise about 13 percent of sales. These ingredients are added to the pot and
listed as an ingredient with a direct cost (e.g., $8 for two pounds of coffee used in a batch). Less
expensive additives, such as flavoring oils (e.g., mint or lavender), are not included in direct
costs as a little goes a long way. These costs usually show up in overhead. Sixteen ounces of oil
cost about $22, and D.C. uses only two ounces for a batch of 1,200 1.25-oz. bars. About 16
5 percent of product sales have these flavoring oils.
??Stir-in?? ingredients are a relatively larger part of the weight of the bar, are clearly
noticeable in the final bar, and affect the overall taste of the bar rather than the chocolate itself.
Bars with stir-in ingredients, such as huckleberries and all nuts, comprise about 24 percent of
sales and add additional direct materials and direct labor costs. Kay estimates $12 per pound
average for nuts, ginger, and huckleberries, and these ingredients become about 5 percent of the
finished weight of the bar. In addition to the direct materials cost for these ingredients, there is
additional labor required for stirring to achieve equal distribution throughout the bar.
Four of the seven production areas have labor costs that should be included in product cost.
Direct labor comes from pouring, inspecting, foiling, and labeling. Table 2 provides the average
labor rates (including benefits) and estimated average number of bars that can be processed in
each of the four labor areas. Notice that larger bars can be inspected twice as fast as the smaller
bars. The reason is that larger bars have fewer defects, so less time is needed. Because each area
might be working on multiple customer jobs at a time, it is difficult to track labor hours for each
customer order. The extra labor cost for ??stir in?? ingredients is handled in one of two ways. If performed by
the Master Chocolatier, whose salary is included in plant overhead cost, Kay considers it as no
additional direct cost. If the Master Chocolatier is busy and other workers will be required, Kay
adds $12.50/hour of labor to each stir-in batch when estimating the cost of a job.
Overhead costs include administrative costs, supplies, three salaried employees (including
Kay, Kathleen, and the Master Chocolatier), an hourly wage customer service person, and lease
payments for the building. Table 3 provides a breakdown of budgeted overhead costs per month
of $19,800, on average. Note that each production area incurs costs for supplies each month. 6 Capacity and Output
Currently, the factory can pour up to about 300 pounds of 1.25-oz. chocolate bars per eighthour day. Different bar sizes can be produced in the same batch. However, as is usually the case,
total factory output is constrained by bottleneck processes, number of qualified workers, and
customer demand. Current budgeted production is 25,000 1.25-oz. bars and 1,000 3.0/3.25-oz.
bars per month, with an estimated average order size of 200 bars. Typically, two-thirds of
production is for organic bars. Kay tries to batch all the non-organic batches together and only
switch from organic to non-organic once a month (there is no difference in setup time between
the two types). There are typically two days of production in work-in-process between the
pouring and foiling areas because that is how long it takes to make and foil the bars.
Kay is optimistic that D.C. can produce the additional 20,000 to 25,000 bars per month
needed for the big special order, but he will need additional equipment and trained workers. He
will also need to add an extra shift, but he must train additional workers first. Training can take
up to two months to be able to meet D.C.?s high standard of quality.
Kay?s Cost Estimates
Table 4 shows how Kay estimates the cost of standard types of bars. When Kay estimates
costs to price a typical order, he adds materials (including ingredients, foil, and label), direct
labor, and overhead costs per bar to get the total estimated cost per bar. For overhead, he
allocates $0.69 per bar based on producing at the bottleneck rate and assuming an average of
20.5 work days per month, one eight-hour shift per day, and one worker per labor area. Markup
percentages vary and are affected by the size of the order and demand. When customers want a
significant discount from the normal price, he will usually decline unless there is a good chance
of future business. He accepted the big order because of the high volume and prospect for more
large orders. 7 8 9 ACTION ITEMS
Now put yourself in Kay Johnson?s shoes and think about what type of costing approach will
help you determine more accurate products costs for pricing different orders, like the recent big
order. In Part A, you will analyze D.C.?s situation, identify its information needs, evaluate the
pros and cons of different costing approaches, recommend an approach, and suggest ways to
implement it. If your instructor assigns Part B, you will calculate product costs based on your
Part A: Choosing a Costing System
A1: What Information Does D.C. Need?
Before recommending a cost system, it is helpful to understand the cost information needs of
the company. Based on case information, briefly summarize D.C.?s competitive environment and
its apparent strategy in response to that environment. Considering the company?s strategy and
products, what types of cost information should D.C.?s product costing system be able to
A2: Which Costing Approach(es) Do You Recommend?
a: Discuss the pros and cons of the different costing approaches available to D.C., including
job order costing, process costing, activity-based costing or hybrid costing (i.e., blending
characteristics from both job-costing and process costing system). Based on your analysis of
costing approaches, which approach do you recommend D.C. Keep in mind it is a small
company with limited staff and they do not currently track actual cost information during
production. The approach should also be flexible enough to handle high-volume or low-volume
b: Discuss how you would handle different types of special ingredients, stir-ins, or labeling
design costs for the new special order from the wellness company. You do not need to state how
you would handle each specific ingredient.
A3: Summary and Implementation
Summarize your recommended costing approach and discuss how it will help Kay determine
more accurate products costs for pricing different types of orders. What specific steps would you
take to implement the new product costing approach? Hint: think about what new information
would need to be collected and how you would collect it.
Part B: Calculate Product Costs
B1: Compute New Standard Product Costs
a: D.C. does not currently track actual cost information, but Kay has estimated some additional
production data provided in Table 5. Using the approach(es) you recommended in Part A and the
estimated data provided in Tables 1?5 and the Case, use Excel to compute estimated total cost,
profit margin, and margin percentage for each of the four jobs identified in Table 5, Panel A.
10 b: Compare your costs and profitability per bar to Kay?s estimates in Table 4. What is the
potential financial impact of using your method instead of Kay?s? 11 12