Case Synopsis

Stuarts Branded Foods, founded by Stuart Daw in 1962, was located in Toronto,
Canada, and mainly a business which roasting and selling coffee. The president wanted to
focus on roasting and selling packaged coffee to customers like restaurants, hospitals,
catering trucks and the like. These customers were in the Away From Home coffee market,
whereby they purchased directly from roasters in a small volume of coffee because it was
convenient and advantageous to them.
Moving on, there were entrepreneurs who formed businesses to be a third man
between roasters and customers. These entrepreneurs purchased a large volume of coffee
from roaster and re-packaged into kits. The kit, which was equivalent to 500 cups of coffee,
was sold to small customers. The customers were also aided with extra services like rented
coffee brewing equipment, free maintenance of equipment, packaged coffee ready for use,
and delivery to the customers location.
As a coffee roaster, Stuarts Branded Foods operated its own roasting plant. They
purchased green coffee needs through a local broker, basically the green coffee beans were
from 45 exporting countries. The roasting process involved from loading the green coffee
beans into a roaster, heating stage and to grinding stage where the beans were ground into
finer particles. In addition, most of the equipment used were aged more than 30 years. The
equipment was also said to be non-labour intensive. Moreover, during the roasting and
grinding process, an approximate 12 per cent of the weight of coffee disappeared due to
moisture loss and this is called shrinkage. Stuart Foods had estimated the cost of green beans
for each pound of roasted coffee produced since there was a shrinkage issue and other
associated costs such as direct and indirect production labour, packaging materials and
depreciation on equipment. These costs were $2.15 and $0.35 per pound respectively.
Moreover, the company had succeed in selling almost $1 million worth of coffee and
handled in the range of 18,000 invoices. Their targeted profit margin was 15% of the sales
dollar and unfortunately, this targeted profit margin had not been attained, instead attained
profit margin of lower than 10% of sales, despite the average selling price of a kit had been
well in line with the industry average. Furthermore, Stuarts Branded Foods was using
traditional pricing approach whereby the operating cost charged were based on the allocation
of the sales and administration cost associated to the kits sold in the previous year. The

company charged operating and equipment costs of $16.20 per kit, considered 27,777 kits
were sold, and $3.24 per kit respectively and marked up the price to earn desired profit.
Furthermore, Stuart Daw had distinguished its customer into two categories, small
and large customer. Normally, small customer, for instance a small office complex would
only ordered 5 kits of coffee monthly, whereas larger customer, a restaurant in downtown
Toronto, would have ordered 20 kits of coffee monthly. Moreover, the former type of
customer was charged $222.08 per five kit including of 23% profit, while the latter was
charged $777.28 for 20 kits with only 12% profit.
Statement of Problem
As a president of the company, Stuart Daw, as a decision maker will decide on his
company direction. Stuart Daw had questioned himself whether the company actually knows
about the true unit cost. The existing costing approach perhaps are not suitable to be used by
Stuart Daw. This could be portrayed as the major concern or problem of the company and
which could be the reason why the company could not achieve its 15% targeted return on
sales. In the case, the company was adopting traditional costing approach in which could be
regarded as unsuitable costing method and this could lead to inaccurate pricing strategy. All
in all, Stuart Daw was concerning whether his company could attain 15% profit margin so
that the company would sustain in the industry.

Diagram 1: Ishikawa Diagram

As major problem of the company was inappropriate costing approach, therefore,
there are several causes which lead to this problem. First of all, the people in the company
itself. Stuart Daw, as a president, should know better about the costing and pricing strategy as
he had experience in coffee industry. In this case, the company was seen as lack of
information gathered by its people, plus lack of expertise or competent people in the
company.
Furthermore, as stated in the case, the company was adopting traditional costing
approach whereby this approach only used one cost driver (the volume produced). The use of
only one cost driver could be deemed as less accurate in allocating cost. For instance, the
vehicle cost charged to the customer. The company divided the vehicle cost over the number
of kits being sold in which this method of calculating was not proper as the company might
deliver the order based on invoices and in each invoice might have different number of kits.
As Stuart Daw was concern about the cost, he did not do adequate planning on how to
calculate the cost of coffee which could affect the final price charged to customer.
On the other hand, the machine used to roast and grind the green coffee beans had
been operated for more than 30 years. Although the process was smooth, except the shrinkage
issue, the company was supposed to use more sophisticated technology as it could yield
better result or outcome for the company. In the case, the company encountered 12% of
shrinkage. Based on research, normal shrinkage percentage is 20% and the lowest it could go
is 11%. Therefore, the 12% shrinkage incurred was not a big problem to the company
because the percentage was in the range of normal shrinkage percentage.
Furthermore, as the company was only roasting and selling coffee, the price itself was
the major influence on the firms profit. If the company charged more, it could earn more.
Otherwise, if it charged less, it could earn less. Based on the case, customers paid from $25 to
$45 per kit for coffee service. This means, Stuarts Branded Foods could only charge
customer in this price range regardless whether it could achieve its targeted profit margin and
its quality of service and the coffee itself. Moreover, the price of the green coffee was one of
the challenges faced by the company. Since the company size was not so big, it could not
afford to purchase a massive amount of green coffee. in addition to this, the quality and price
levels of coffee beans were spread over a fairly wide spectrum. As stated in fairtrade website,
International Coffee Agreement was negotiated between international governments to
stabilize the coffee market in 1962.

As external factor, the company had to compete with a broad range of competitors
from giant roasters such as Maxwell House to local roasters who handled the market. This
leads them to have a stiff high competition, in the price as well as the strategy, within the
coffee industry. In addition, the small customer tended to take advantage over the roaster
whereby they preferred to purchase coffee directly from roaster as this would cost them
lesser. As mentioned in the case, the cost incurred to serve this type of customer was higher
than the profit generated by this sale transaction.
On top of that, the companys gross profit margin ratio was calculated and yield of
50% (1,000,000/500,000). This indicates that the company could make a reasonable profit, as
long as it keeps the overhead cost in control. Next, its net profit margin of 5% indicated that
the company was able to control its costs, however, it could not make more profit. This is not
necessarily deemed as less efficient than its competitors.
Alternatives
There are two alternatives available to be used by Stuart Daw in addressing their
current problem either by using Activity-Based Costing (ABC) or status quo. Status quo
means that the current traditional costing approach will be remain the same without accepting
any changes. Changing the whole costing system will need more time and cost. Thus, there
will still be an option for Stuart Daw to remain with the traditional costing that they have
been using for the past years because the existing approach are still able to contribute 5%
return on sales on last year. However, if the company continue using existing approach, it
might effect them in a long run because they actually allocate lower cost. In the Table 1
below, a comparison were made to compare between the two approaches.
On the other hand, as coffee manufacturing has a specific process, Stuart Daw may
consider using ABC as their second alternative. According to CIMA Official Terminology
(2005), activity based costing is one of the tools of costing and to monitor activities which
involves resources consumption tracing. In ABC, it will use cost drivers to calculate the cost
which attach to specific activity to output. To implement ABC, Stuart Daw need to hire
expertise to change the whole costing system. As an organisation, the management are also
required to take part in the changing process.
Based on the following table, the different allocation of the cost driver in the two
types of costing approach can be summarised as follows:

Cost driver

Traditional Costing

Activity-based Costing

No. of kits sold

27,777 kits

No. of invoices

18,000 invoices

Cost of coffee per kit

$500,000/27,777 =

$18.00

$500,000/27,777 =

$18.00

Equipment costs

$90,000/27,777 =

$3.24

$90,000/27,777 =

$3.24

Personnel costs

$220,000/27,777 =

$7.92

$220,000/18,000 =

$12.22

Vehicle costs

$70,000/27,777 =

$2.52

$70,000/18,000 =

$3.89

Other overhead costs

$70,000/27,777 =

$2.52

$70,000/18,000 =

$3.89

Total cost

$34.20

$41.24

Table 1.1
As mentioned before, current practice within the Stuarts Branded Foods which
referring to traditional costing, have been using the total number of kits produced as the main
cost driver. Whereas, using Activity-based costing (ABC) could be the most suitable costing
approach in assigning appropriate cost driver to each of the relevant costs incurred. Indeed,
the selection of cost driver of each activity or process where cost incurred is very crucial in
deriving much more accurate result on cost-allocation on the product. According to Blocher,
Stout, Cokins & Chen (2010), the ABC can be defined as follows,
.... used to improve the accuracy of cost analysis by improving the tracing of costs to
products or to individual customers.
In ABC, the suitable cost driver to be used for cost of coffee and equipment cost
remain the same as they were using the number of kits sold. However, it is found that the
number of invoices issued could be the most suitable cost driver for the other operating costs
that includes personnel costs, vehicle costs as well as the other overhead costs. The reason
being that, there is possibility that the number of kits ordered by the customer may vary in the
single invoice, yet, the delivery of the product in the case of vehicle could be lessen to a onetime charge in corresponding to one invoice assuming one invoice represents one customer.
Similar case with the personnel cost, there could be one invoice handled by personnel in

which it is more appropriate to be allocate as its cost driver rather than the number of kits that
merely interpreted in average cost per kit.
Observing from the table above, the total cost incurred in ABC showing greater
amount than the traditional costing. From this, we can observe that if Stuart Daw did not
address proper costing method, he was actually charge lower cost and price to his customer
than what it is supposed to be.
Traditional Costing

ABC Costing

SMALL CUSTOMER (5 kits)

Cost of coffee

5 kits X $18.00 =

$90.00

5 kits X $18.00 =

$90.00

Equipment costs

5 kits X $3.24 =

$16.20

5 kits X $3.24 =

$16.20

Other operating costs

5 kits X $12.96 =

$64.80

1 invoice X $20.00 =

$20.00

Total cost

$171.00

$126.20

LARGE CUSTOMER (20 kits)

Cost of coffee

20 kits X $18.00 =

$360.00

20 kits X $18.00 =

$360.00

Equipment costs

20 kits X $3.24 =

$64.80

20 kits X $3.24 =

$64.80

Other operating costs

20 kits X $12.96 =

$259.20

1 invoice X $20.00 =

$20.00

Total cost

$684.00

$444.80

Table 1.2
Referring to Table 1.2, assuming in every month, one large customer will buy 20 kits
and the small customer will buy 5 kits. The total cost using ABC will be more accurate
compared to the existing traditional approach. The difference can be seen in the computation
of other operating cost. Currently, number of kits is the cost driver for the traditional
approach. For example, as vehicle cost is a part of the other operating cost, this may be
irrelevant to allocate the cost per kit. As discussed above, assuming that one invoice is for one
customer (5 kits for small customer and 20 kits for large customer), the distance might not the
same.
Recommendation

Activity-based costing deemed to be the most appropriate approach to be used in

improving the existing costing and pricing approach used by Stuart Daw. This is because the
coffee process undergo specific activity to become the final output. It is crucial to allocate the
true cost of coffee per kits. By understanding the process and the cost driver, the cost
allocation will be much more accurate. As presented in Table 1.1, with the existing costing,
Stuart actually charge lower to the customer while the actual cost were higher. This shows
that with ABC, it gives better profitability measure. In addition, implementation of ABC
helps to give better decision making and improving the process.
To implement ABC, firstly Stuart Daw should hire expertise in order to change the
whole system. Then, a data collection should be made such as the process, activity, resource,
cost driver and cost object. This is the important element that are needed to implement ABC.
By changing the costing, it requires participation and acceptance by the whole management
including from top management until lower management. Thus, it will take time but with
encouragement from the top management, it might be possible to implement the new costing
system.
In a nutshell, after analyzing the case, the major problem that are faced by Stuart Daw
is the costing and pricing approach where they use the traditional approach. This resulting to
inaccurate costing. Alternatives that are available to them are status quo and ABC. By
implementing ABC, they can have more accurate costing approach and better profitability
analysis. However, implementing ABC requires cost and takes time. In addition, it needs
cooperation from management.

References
Blocher, E.J, Stout, D.E, Cokins, G & Chen, K.H (2010) Cost Management: A Strategic
Emphasis (5 . Ed.), New York: McGraw Hill.
th

Edwards, S (2008). Activity Based Costing: Topic Gateway Series No. 1[e-book]. Retrieved
from
http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_
nov08.pdf.pdf
Jamie Oliver | Member Recipes | Gourmet Coffee Roasting Facts . Retrieved from
http://www.jamieoliver.com/recipes/member-recipes/recipedetail/1962/#dXDYEL7osmFkm7Kb.97
Coffee (Fairtrade International /Product).
Retrieved from : http://www.fairtrade.net/coffee.html#c3805