Activity Cost Drivers and Cost Estimation Market Street Soup Company produces ten varieties of soup in large vats, several thousand gallons at a time. The soup is distributed to several categories of customers. Some soup is packaged in large containers and sold to college and university food services. Some is packaged in half-gallon or small containers and sold through wholesale distributors to grocery stores. Finally, some is packaged in a variety of individual servings and sold directly to the public from trucks owned and operated by Market Street Soup Company. Management has always assumed that cost fluctuated with the volume of soup, and cost-estimating equations have been based on the following cost function: Estimated costs = Fixed costs + Variable costs per gallon x Production in gallons Lately, however, this equation has not been a very accurate predictor of total costs. At the same time, management has noticed that the volumes and varieties of soup sold through the three distinct distribution channels have fluctuated from month to month. Required a. What relevant major assumption is inherent in the cost-estimating equation currently used by Market Street Soup Company? b. Why might Market Street Soup Company wish to develop a cost-estimating equation that recognizes the hierarchy of activity costs? Explain. c. Develop the general form of a more accurate cost-estimating equation for Market Street Soup Company. Clearly label and explain all elements of the equation, and provide specific examples of costs for each element.
Activity Cost Drivers and Cost Estimation
Market Street Soup Company produces ten varieties of soup in large vats, several thousand gallons at a time. The soup is distributed to several categories of customers. Some soup is packaged in large containers and sold to college and university food services. Some is packaged in half-gallon or small containers and sold through wholesale distributors to grocery stores. Finally, some is packaged in a variety of individual servings and sold directly to the public from trucks owned and operated by Market Street Soup Company. Management has always assumed that cost fluctuated with the volume of soup, and cost-estimating equations have been based on the following cost function:
Estimated costs = Fixed costs + Variable costs per gallon x Production in gallons
Lately, however, this equation has not been a very accurate predictor of total costs. At the same time, management has noticed that the volumes and varieties of soup sold through the three distinct distribution channels have fluctuated from month to month.
Required
a. What relevant major assumption is inherent in the cost-estimating equation currently used by Market Street Soup Company?
b. Why might Market Street Soup Company wish to develop a cost-estimating equation that recognizes the hierarchy of activity costs? Explain.
c. Develop the general form of a more accurate cost-estimating equation for Market Street Soup Company. Clearly label and explain all elements of the equation, and provide specific examples of costs for each element.
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