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Apr 3, 2024

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To: Ms. Mona Clin, Controller – Coffee Bean Inc. From: Mr. Sukhbir Singh Sodhi Date: March 5, 2024 Subject: Analysis of current costing approach and ABC approach Overview: Coffee Bean Inc. is a processor and distributor of coffee. Its strategy is product differentiation and quality. This is complemented by their product mix which contains 15 different kinds of coffee. They are currently facing a dilemma regarding choosing a more accurate product costing approach. The stakeholders that are concerned by this case analysis is Ms. Mona Clin who is the controller of Coffee Bean Inc. Problem Statements: 1. Difference between product cost and selling price for Mona Loa Coffee and Malaysian Coffee under current costing approach and activity- based costing. 2. Implications of implementing ABC system to product pricing Analysis: Problem 1: Difference between product costs and selling price for Mona Loa Coffee and Malaysian Coffee under current costing approach and activity-based costing. Alternative 1: Keep using the current costing method. - Factory overhead is allocated using a single cost driver i.e. the direct labour cost. - Using this approach, the total product cost for a pound of Mona Loa Coffee and Malaysian Coffee will be $6 and $5 respectively. Out of these, the direct costs are $4.5 and $3.5, respectively and factory overhead are $1.5 each. - After the 30% markup, the selling price for a pound of Mona Loa Coffee and Malaysian Coffee will be $7.8 and $6.5 respectively. Alternative 2: Switch to using ABC costing method. - Factory overhead is broken down into different production activities. The costs of each of these activities are then allocated by using a different cost driver for all of them. - Using this approach, the total product cost for a pound of Mona Loa Coffee and Malaysian Coffee will be $4.82 and $7.46 respectively. For this, the direct costs remain the same as last approach, but the

factory overhead allocations change to $0.32 and $3.96 respectively for the brands. - After the 30% markup, the selling price for a pound of Mona Loa Coffee and Malaysian Coffee will be $6.27 and $9.7 respectively. Conclusion: By making a switch of ABC approach, the total cost of Mona Loa Coffee decreases by $1.18, whereas the total cost of producing Malaysian Coffee increases by $2.46. Due to this change, the selling price their selling price change by -$1.53 and +$3.2 respectively. I would suggest Mona Clin to use ABC approach as it provides a more detailed as well as more accurate allocation of overhead. If they stick to their current costing approach, then there is a high chance that they may overcharge for some of the products and have negative contribution margin for others, which will always keep some product offering as a loss maker. Problem 2: Implications of implementing ABC system to product pricing - By implementing ABC, the pricing of the products will be more favourable for the firm as a markup on an accurate product cost will increases chances of the actual contribution margin being positive. - Some products’ selling price will be decreased which will boost sales for those brands, like the Mona Loa Coffee. Whereas some products’ selling price will be increased, which might lead to a substantial decline in sales. Alternative 1: Due to the change in price, the demand will be substantially affected as their customers are price sensitive. This may require Coffee Bean Inc. to discontinue some of the product lines which show a significant decline in demand, which might negatively affect their strategy of product differentiation. Alternative 2: Due to drastic changes in the production costing of products, Coffee Bean Inc. might want to start pricing their products using a different markup rate across all their brands. This would allow them to keep their prices more balanced than alternative 1, which would allow them to keep moving on with their current lineup of coffee brands there reinforcing their strategy of product differentiation and not product pricing. They can use a higher markup for the brands that are cheaper to produce, and a lower markup rate for the ones that are more expensive to produce. Conclusion: By making a switch of ABC approach, the total product costs will be more precisely calculated for all their coffee brands, which will lead to a positive contribution margin for all of them after markups. Some brands will become cheaper, and some will become more expensive. I will

recommend Coffee Bean Inc. to not discontinue those products but instead use different markup rates for all their coffee brands, to maintain a more balanced price across their offerings, while keeping a positive contribution margin, and sticking to their strategy of product differentiation. Overall Recommendations: - Implement ABC costing for more accurate product costing. - Review product pricing strategy by using different markup rates for all the products. - Keep following the strategy of product differentiation instead of trying to be a price leader. Implementation Plan:  Short Term: - Measure the cost driver consumption for all the production process across all the 15 brand offerings to update the product costs. - Come up with new markup percentages specific to all the 15 brand offerings. - Monitor and evaluate the changes caused by the pricing on the demand of all the product offerings.  Long Term: - Invest in plant and equipment which are more efficient thereby leading to lower factory overhead costs to be allocated. - Diversify into more product offerings for enforcing their image as a quality-oriented supplier, who focusses on product differentiation. - Maximising the utilization of their production capacity to take advantage of economies of scale and declining, per unit, overhead allocation.

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