Niagara Winery makes two different grades of wine—regular wines and specialty wines. Recently, Niagara has shown small profits on its regular wines and large profits on its specialty wines. As a result, management is considering getting out of the regular wine business and concentrating on specialty wines. This is a difficult decision because Niagara had been very profitable in regular wines, its original business. In fact, the profitability of regular wines dipped sub- stantially only after Niagara got into the specialty wine business. Before making a decision, Niagara wants to be sure that it understands what it costs to make and sell the regular and specialty wines. This question focuses on costs in the distribution area.
Niagara distributes the regular wines and the specialty wines through completely different distribu- tion channels. It distributes 120,000 cases of the regular wines through 10 provincial distributors and 80,000 cases of the specialty wines through 30 specialty distributors. Niagara incurs $2,636,000 in distribution costs. Under its existing costing system, Niagara allocates distribution costs to products based on cases shipped.
To understand better the demands on its resources in the distribution area, Niagara identifies three activities and related activity costs:
1. Promotional activity including advertising and point-of-sale material at each distributor. Niagara esti- mates it incurs $9,600 per distributor.
2. Orderhandlingcostsincludingcoststoconfirmandinputtheorderintotheorder-entrysystem,setaside the correct number of cases, organize shipment and delivery, verify order packing, ensure delivery, send invoices, and follow up for payments. Niagara estimates costs of $360 for performing all the activities pertaining to each order. Niagara’s records show that distributors of regular wine placed an average of 10 orders per year, while distributors of specialty wine placed an average of 20 orders per year.
3. Distribution costs of $10 per case for freight.
1. Calculate the total distribution costs and distribution cost per case for the regular wine and the spe- cialty wine using Niagara’s existing costing system.
2. a. For each activity, classify the cost of the activity as an output unit-level, batch-level, product-sus- taining, service-sustaining, or facility-sustaining cost. Explain your answers.
b. Calculate the total distribution costs and distribution cost per case for the regular wine and the spe- cialty wine using Niagara’s activity-based costing (ABC) system.
3. Explain the cost differences and the accuracy of the product costs calculated using the existing and the ABC systems. How might Niagara’s management use the information from the ABC system to man- age its business better?
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