Case Analysis Project Report for Cost

Management
PGPEM-2019

Case 3.1 (Activity Based Costing)

Group 3
Goutam Mandal (1916034)
Jatinkumar Maniya (1916035)
Gulam Nabi (1916040)
Vinay Arakali Nagaraja Rao (1916041)
Pusparghya Pakrasi (1916043)
Nandan Palavalli Devarajulu (1916044)
Vijay Satam (1916057)

1
 Context and business problem

 Chocorp, established in 2004, tasted success with their first product Dark Bars which is
selling 2.4M units annually with 60% capacity. The company followed the process of
allocating overheads based on units produced
 When the company launched other chocolate products – Dark chocolate chips and Dark
chocolate beans along with their flagship product after 4 years with remaining capacity, it
started to witness a dip in profit of flagship product (Dark Bars) even though units, price,
direct costs (such as Material, Labour) and Manufacturing expense to come down. Selling &
Distribution (S&D) expense and Administrative expense seems to be the issue
 The portfolio seems to be profitable overall and Marketing manager feels that’s more
important that focusing on 1 product. The CEO isn’t satisfied with the response and wants to
understand the root cause of this phenomenon

Why is this possibly happening?

 The dip in profits of Dark bars in a multi-product setup can be due to overhead cost
allocation technique which was based on units. Dark bars having the highest production
quantity among the 3 products resulted in higher allocation of indirect costs such as Selling
& Distribution (S&D) expense, Administrative expense in multi-product setup as compared
to initial stage (when it was the only product). High volume products’ costs get
overestimated in multi-product setup and this is expected to happen. The solution to this
problem is to adopt Activity based costing (ABC) approach in allocating overheads to
products

Profit statements of multi-product setup under Traditional and ABC approaches:

(a) Profit statements:

Traditional approach (in Mn) ABC approach (in Mn)
Dark Dark
Dark bars Dark bars
Dark bars chocolate Total Dark bars chocolate Total
chocolate chocolate
beans beans
Units 2.4 1.2 0.4 4.0 2.4 1.2 0.4 4.0
Price 50.0 80.0 100.0 50.0 80.0 100.0
Sales value 120.0 96.0 40.0 256.0 120.0 96.0 40.0 256.0
Material 28.8 24.0 10.0 62.8 28.8 24.0 10.0 62.8
Labour 12.0 9.6 3.6 25.2 12.0 9.6 3.6 25.2
Manufacturing expense 22.5 11.3 3.8 37.5 27.0 15.2 8.7 50.9
Selling & distribution
44.5 22.3 7.4 74.2 38.4 31.2 16.4 86.0
expense
Admin expense 2.7 1.4 0.5 4.5 1.5 1.5 1.5 4.5
Total cost 110.5 68.5 25.2 204.2 107.7 81.5 40.2 229.4
Profit 9.5 27.5 14.8 51.8 12.3 14.5 -0.2 26.6
Table 1

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 (b) Comparison of Indirect, Total costs and Profit between the 2 approaches:
Comparison in Traditional vs. ABC approaches
Formula used: (ABC approach value – Traditional approach value)/Traditional approach value
Dark bars Dark bars chocolate Dark chocolate beans Total
Manufacturing
20% 35% 132% 36%
expense
Selling & distribution
-14% 40% 121% 16%
expense
Admin expense -44% 11% 233% 0%
Total cost -3% 19% 59% 12%
Profit 30% -47% -101% -49%
Table 2

Note:

Comparison value What it indicates Examples

 all the indirect costs and total costs have increased for Dark
Positive % cost overhead has INCREASED in ABC
Bars chocolate and Dark Chocolate beans
(Red) approach compared to Traditional approach
Costs  For Dark bars, Manufacturing expense has actually increased
Negative % cost overhead has DECREASED in ABC  S&D expense, Administrative expense, Total cost for Dark
(Green) approach compared to Traditional approach bars
Positive % Profit has INCREASED in ABC approach
 Profit for Dark Bars
(Green) compared to Traditional approach
Profit
Negative % Profit has DECREASED in ABC approach
 Profit for Dark Bars chocolate and Dark Chocolate beans
(Red) compared to Traditional approach

Executive summary:

 For Dark bars: Using ABC approach of cost allocation, we see profit of Dark bars to rise back
to INR 12.3M, similar to initial days of INR 12.2M (shown in Table 1). This is because S&D
expense, Administrative expense came down by 14% and 44% respectively (shown in Table
2) as compared to traditional approach in multi-product setup although Manufacturing
expense went up by 20% (shown in Table 2). This has resulted in lower cost under ABC
approach and hence profits went back as per leadership expectation
 For the other 2 products: Manufacturing expense, S&D expense went up significantly
leading to 19% and 59% increase in Total cost for Dark bars chocolate and Dar chocolate
beans respectively (shown in Table 2). Admin expense also went up significantly for Dar
chocolate beans under ABC as compared to Traditional allocation. This led to reduction in
profits for both these new products, with 47% and 101% decline in profits for Dark bars
chocolate and Dar chocolate beans respectively (in table 2). The profit margin for Dar
chocolate beans is Negative under ABC approach, this product is bleeding.

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  For the total portfolio: Manufacturing and S&D expenses were both underestimated in
Traditional approach. Using ABC, we see the costs for these overheads went up by 36% and
16% respectively compared to Traditional approach (in table 2), which has led to increase in
Total cost by 12% and decline in profit for the firm by 49% ((in table 2)
Key takeaway: While the flagship product is doing well in terms of profit as expected by
leadership, ABC approach reveals the firm overall isn’t doing as well as they thought and
need to reconsider their costing structure and strategy in market.

 ABC approach has also revealed granular information on the cost components that make up
Manufacturing expense, S&D expense and we can analyse which cost components are
hurting the most – by product types and total portfolio. It provides data for better decision
making
a. Manufacturing expense (refer to chart 1):
i. Product cost (which is direct allocation of 5M each product) is the highest
share for Dark chocolate beans. Given the low quantity, the firm can find
ways to reduce this cost structure
ii. At an overall level, Machine operation and Product costs make up 60% of
manufacturing expense

Split of Manufacturing expenses

100%

50%

0%
Dark bars Dark bars chocoate Dark chocolate Total
beans
Supervision QC Product cost Cost of setup Material handling Material procurement
M/c operation

Chart 1

b. Selling & Distribution (S&D) expense (refer to chart 2):

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 i. Similar to Product cost, Promotion cost (which is direct allocation of 6M
each product) is one of the highest shares under S&D expense for Dark
chocolate beans. Given the low quantity, the firm can find ways to reduce
this cost structure
ii. At an overall level, Commission on sales costs make up 60% of S&D expense.
The firm can find avenues to reduce this by incentive-based commissions.
Promotion which makes up 18% of S&D expense can also be brought down
using partner/retailer tie-ups.

Split of Selling & Distribution expenses

100%

50%

0%
Dark bars Dark bars chocoate Dark chocolate Total
beans
Promotion Distribution expense Commission on sales Discounts & offers

Chart 2

120.0 Product wise cost - Traditional & ABC

100.0
80.0
60.0
40.0
20.0
-
-20.0

Manufacturing expense Selling & distribution expense Admin expense

Total cost Profit

Appendix:

5
 0 10 Across
20 all products
30 40 50 60

204
5
Traditional 74 52
37
25
63

229
5
ABC 86 27
51
25
63
0 50 100 150 200 250

Total cost Admin expense Selling & distribution expense Manufacturing expense Labor
Material Profit

Chart 3
Chart 4

Worksheet embedded->

Cost management
case analysis 3.1.xlsx