Case 18-2: California Creamery, Inc.

California Creamery, Inc. (CCI) owned and operated 14 retail ice cream stores
spread throughout Southern California, from San Luis Obispo to San Diego, CCIs
stores sold only the highest-quality, ultra-premium ice cream. They offered 25
different ice cream flavors. Many of the CCI flavors were exotic, such as
Polynesia Fantasy, Mango-Lemon Supreme, and Multi-Nut Twist. But CCI
also sold a few traditional ice cream flavors, such as vanilla, chocolate, strawberry,
and coffee. Some of the flavors were very popular, but a few of the exotic flavors
sold in low volumes.
CCI produced its own ice cream. Originally the ice cream was produced in
the garage of the companys founder, Will Forgey. But the company outgrew the
garage, and Will had since leased a building to house CCIs production activities.
As CCI had grown, Will had been able to afford more expensive, automated
manufacturing equipment that blended the flavors and packaged the liquid ice crem
in preparation for freezing. CCIs most significant production costs were for raw
materials, particularly cream, sugar, and the special flavor ingredients, and for the
acquisition, operation, and maintenance of the production equipment.
All of CCIs products were sold at the same retail price. Will set the prices to
yield, roughly, a markup of 100 percent on average full production costs. CCIs
2004 budget included manufacturing overhead of $600,000. To estimate product
costs, Will spread this overhead cost to products based on a proportion of the direct
labor used in the production process. CCIs total direct labor cost for 2004 was
$300,000, so Will charged the overhead to products at a rate of 200 percent of direct
labor costs.
One day in a causal conversation, Louise Fettinger, Wills neighbor and a
controller of a small manufacturing company, suggested that Wills pricing policy
was not very smart. Louises intuition was that the costs of producing CCIs various
flavors were very different. She thought those differences should be reflected in the
prices charged, or CCIs profits would vary as the mix of products sold varied.
Louise suggested that Will reestimate product cost using what she called an
activity-based cost system. Toward that end, she suggested that he identify the
major activities whose costs were included in the companys overhead costs. Then
he should apply those costs to products based on the products consumption of each
of those activities. In response to Louises suggestion, Will prepared the information
shown in Exhibit 1.
Then, again following Louises suggestion, he decided to calculate the costs
of two illustrative products as an experiment to see if Louises new cost system idea
produced any material differences. He asked Louise to take her best guess as to
where he might find the most significant differences, if any existed. After Will
described the products to her, Louise suggested that he use Polynesian Fantasy and
Vanilla as the test product examples. Exhibit 2 provides data pertinent to those two
products.

Exhibit 1
CALIFORNIA CREAMERY, INC.
2004 Budgeted Manufacturing Overhead Costs
Activity
Purchasing
Material Handling
Blending
Freezing
Packaging
Quality Control
Total manufacturing
overhead costs

Budgeted Cost
($000)
80
95
122
175
110
18

Driver of the Activity

Costs
Purchase orders
Setups
Blender hours
Freezer hours
Packaging machine hours
Batches

Budgeted Activity Level

for the Cost Driver
909
1,846
1,000
1,936
1,100
286

600

Exhibit 2
CALIFORNIS CREAMERY, INC.
Two Product Examples (2004 Data)
Polynesian Fantasy
Vanilla
Direct material
$2.00/gallon
$1.80/gallons
Direct labor
1.20/gallon
1.20/gallons
Budgeted production and sales
2,000 gallons
100,000 gallons
Batch size
100 gallons
2,500 gallons
Setups
3 per batch
3 per batch
Purchase order size
50 gallons
1,000 gallons
Blender time
0.6 hour per 100 gallons
0.3 hour per 100 gallons
Freezer time
1.0 hour per 100 gallons
1.0 hour per 100 gallons
Packaging machine time
0.3 hour per 100 gallons
0.2 hour per 100 gallons

Questions
1. Compare the full production cost (per gallon) of the Polynesian Fantasy and
Vanilla products using
a. Wiiols old costing method.
b.
2. What are the effects, if any, of changing
a. Their effect on individual