Forrest Hill Paper Company

Topics: Cost accounting, Profit, Costs Pages: 5 (1111 words) Published: December 11, 2013
TO: Professor and Manager
FROM:
SUBJECT: Forrest Hill Evaluation of Profits and Costing Systems DATE: November 1, 2013

Executive Summary

Throughout this report, our team will describe how we used activity based costing to allocate costs, illustrate why the traditional system is faulty, and recommend changes that Forest Hill Paper Company should consider implementing in the near future. After closely reviewing the financial and production data, our accounting team has found that your traditional cost allocation is faulty and misleading. The costs of products A and C were over allocated and products B and D were under allocated causing deceptive information on the true profits of the company. Also, product B appears to be making a profit, however, it is losing $2307 per reel. As suggested, the assets of Forest Hill Paper Company have not been used to the greatest advantage. For instance, the most lucrative product was found to be D with a profit of $5,299 per reel; whereas the least profitable product was B with a loss of $2,307 per reel. It was also found that slitting costs were being allocated to all of the products when in reality, slitting should only be allocated to products A and C. This is important because slitting contributes an estimated $2,300 of costs per reel; a cost that should not be assigned to products B and D. Our team has reviewed several alternatives for Forest Hill to consider to generate a higher profit margin. For instance, it may be effective to discontinue the slitting service if it wouldn’t drastically affect your current customer base. Additionally, the FHPC accountants should become more familiar with ABC costing system to have a better understanding of the company’s cost allocations and profits.

Analysis of Costing

After analyzing the company’s costing procedures, the traditional costing system has a very different outcome for the profit as opposed to the activity based costing system. To get the profit for traditional costing, we took the overhead rate of 105% and multiplied it by the materials cost. We then subtracted this and the materials cost from the sales price to get the profits shown in the table below.

Traditional Costing
Product
Average Reels per Batch
Price
Materials Cost per Reel
Contribution Margin
Overhead Cost per Reel
Profit (Loss)
A
50
$12,600
$4,800
$7,800
$5,040
$2,760
B
2
$13,500
$5,200
$8,300
$5,460
$2,840
C
35
$14,200
$5,600
$8,600
$5,880
$3,000
D
175
$19,500
$7,400
$12,100
$7,770
$4,330

To calculate the new volume based overhead rate after removing grade change and slitting costs, we took each product’s number of reals and multiplied it by material cost per real. Then we divided that number by the total cost of producing all four products. We calculated the new volume based overhead rate to be 91 percent. Next, we calculated the cost of grade change per reel for each product. To do this, we took the total grade change and divided it by the number of products, four, and divided that number by the average reals per batch for each product. Then, we better allocated the cost of slitting. To do this, we took the products that are slit, A and C, and took the total cost for slitting and divided it by 85, the average reels per batch for products A and C. The profit of each reel in the ABC costing system is shown below.

ABC Costing
Product
Average Reels per Batch
Price
Materials Cost per Reel
Contribution Margin
Overhead Cost per Reel
Profit (Loss)
A
50
$12,600
$4,800
$7,800
$6,897
$903
B
2
$13,500
$5,200
$8,300
$10,607
$(2,307)
C
35
$14,200
$5,600
$8,600
$7,726
$874
D
175
$19,500
$7,400
$12,100
$6,801
$5,299

The traditional costing system that was in place was ineffective and inaccurate. This costing system over allocated costs to A and C, and under allocated costs to product B and D. Consequently,...
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