ACE FERTILIZER COMPANY:
ETHICAL COST ALLOCATIONS AND
PRICE DETERMINATION
Presented By:
Brittany Chumbley
D.J. Gastador
Don Muller
Tyler Patton
Industry Report
• Nitrogen(N), phosphorous(P) and potassium(K) are the three primary
components of fertilizer.
• Top three fertilizer-utilizing U.S. crops: corn, wheat, soybeans.
• Top five fertilizer-consuming states: Illinois, Iowa, Ohio, Texas,
Indiana.
• The fertilizer manufacturing industry is responsible for approximately
33,000 jobs in the United States.
• Fertilizer production facilities are located in 34 states.
• The U.S. nitrogen fertilizer industry operates production plants in 27
states, the phosphate fertilizer industry operates production plants in
12 states and potash is mined in Michigan, New Mexico and Utah.
• The United States is the second largest producer and consumer of
fertilizer in the world. China is the first in both categories.
• Research shows that fertilizers account for at least one-third of all
crop yields in the world.
• The fertilizer industry has annual revenue of approximately $10 billion.
pulse.pharmacy.arizona.edu
Facts
• Abby Conroy (Assistant Director) – Abby is responsible for the design, bidding,
manufacture, and ultimate delivery of special order to customers. Abby develops and
completes all special order contracts.
• George Smilee (Director of Manufacturing) – George initials his approval of the
contracts and forward them to the chief operating officer.
• Tom Brennen (Chief Operating Officer) – Tom gives final approval.
• Special order, unless specific authorization is obtained from Tom himself, must be
billed at 80 percent over the cost of the order.
• Abby could allocate indirect costs to special orders using activity-based costing.
Rather than simply allocating indirect costs among special orders using a companywide rate, ABC acknowledges that not all costs are driven by output volume.
• Breeland Ltd. requests a special order needing a cleaning solvent that needs 40 gallons
of XO-1600. This substance only comes in 50-gallon drums.
• XO-1600 has a shelf life of only 20 days once the drum is opened. After 20 days, the
substance becomes unstable and must be discarded. The price of discarding the
substance is $10,000.
• No other orders exist for XO-1600. Furthermore, Breeland Ltd. is not interested in
taking possession of the unused gallons.
Facts
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Direct materials:
Non-XO-1600
XO-1600: Purchase cost
Disposal cost
Direct labor
Unit-level activity cost ($40 * 4,000 gallons)
Batch-level activity cost ($5,000 * 4 batches)
Product-level activity cost
Customer-level activity cost
Organization-sustaining level activity cost
(20,000+80,000+10,000+30,000+160,000+20,000
Total costs of Breeland Ltd. special order
Markup on cost ($750,000/.80)
Total Price Determination for Breeland Ltd. Order
$ 20,000
80,000
10,000
30,000
160,000
20,000
80,000
30,000
320,000
$ 750,000
900,000
$1,650,000
Facts
• George Smilee discovers his brother, Josh, would be willing to
purchase the remaining 10 gallons of XO-1600.
• Abby suggests that the price quote for Breeland Ltd. be delayed in
order to revise it due to Josh purchasing the unused gallons.
However, George is against this delay.
• George wants to bill the 10 gallons of XO-1600 twice while the
disposal costs would not be incurred. This event adds $93,600
($16,000 for the 10 gallons of XO-1600, $10,000 of eliminated
disposal costs, and $41,600 for markup on the cost of the 10 gallons
of XO-1600) to the company’s bottom line.
• If they do not do this, they would not meet their monthly profit
goal.
Question # 1
Did Abby compute the cost of the Breeland Ltd. special order
correctly before the weekend get-together? If not, how was her cost
estimate and/or price determination flawed?
Answer
• No, Abby did not compute the cost directly. She divided the 80%
markup instead of multiplying the costs then adding them.
Question # 2
Whose assessment of the costing of this special order do you believe
is correct – George Smilee’s or Abby Conroy’s? That is, should
George’s conversations with Josh impact Abby’s cost estimate of the
Breeland Ltd. special order?
Answer
• Abby’s assessment for the cost of the special order is correct.
Company policy mentions that the full costs should be billed, unless
there is an order for any materials that go unused. George believes
that Breeland Ltd. should still be billed the costs incurred with the
10 unused gallons. He wants to charge them for the disposal of the
substance when it would not be disposed of. If the order Josh
makes is finalized, then these extra charges are not necessary.
Question # 3
Are there any ethical issues related to the cost determination on the
Breeland Ltd. special order? If so, what issues are present? How
should Abby resolve these conflicts? Should Abby go directly to Tom
Brennen about this new development? How can Abby use the IMA
Statement of Ethical Professional Practice as a guide for her actions?
Answer
• Ultimately, it is George’s responsibility to disclose the information.
It would be unethical for him to withhold this information from
approval by Tom. Abby’s decision to revise the order is ethical. She
does not want to bill Breeland Ltd. charges that they have not
incurred. According to the IMA guide, Abby should contact Tom
and disclose this information to him. This information is important
to Tom because it aids him in finalizing the approval on the orders.
Question # 4
If Abby were to modify her original cost estimate of the Breeland Ltd.
special order to include Josh’s purchase of the remaining 10 gallons
of XO-1600, what price determination would she have arrived at?
What impact would that have had on Ace Fertilizer’s bottom line?
Answer
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The adjusted price would be as follows:
Direct materials:
Non-XO-1600
XO-1600: Purchase cost (80,000 x 40/50)
Disposal cost
Direct labor
Unit-level activity cost ($40 * 4,000 gallons)
Batch-level activity cost ($5,000 * 4 batches)
Product-level activity cost
Customer-level activity cost
Organization-sustaining level activity cost
(20,000+64,000+0+30,000+160,000+20,000
Total costs of Breeland Ltd. special order
Markup on cost ($698,000*.8)
Total Price Determination for Breeland Ltd. Order
The total price would be reduced by $393,600 (1,650,000 - 1,256,400).
$ 20,000
64,000
0
30,000
160,000
20,000
80,000
30,000
294,000
$ 698,000
558,400
$1,256,400
Additional Issues
• The company should look into not being so family oriented in order
to avoid these types of situations in the future.
• The company should look into implementing more internal controls
and having more than one person approving an order.
Conclusions and Recomendations
A recommendation for Abby would be to disclose the information to
Tom. The information that George is withholding may affect the
decision on whether or not Tom approves the order or not. It would
be unethical for Abby to also withhold this information from Tom.
Another recommendation would be to put the employees through
ethical training in order to avoid these types of conflicts in the future.
Furthermore, personal relationships with coworkers outside of work
should be avoided. This would help stop the pressure that
employees like Abby have to face from higher ups. Creating a
committee to verify the information on all order would also help the
company. This would help with all information being disclosed.
Furthermore, it would allow the information that managers receive
to be accurate.