South Dakota Microbrewery

Case Study
Kurran Singh
October 26, 2015

3.

The advantages of the plant-wide allocation based solely on direct labor hours are the

simplicity of calculation, meaning that both the data as well as the actual math involved are
comparatively simple and easy as opposed to the more complex activity-based cost system. Thus,
it is quicker and easier to use, and is useful for small companies with only one product line, or
only a few very similar products. The disadvantages however are quite significant. The plantwide allocation system tends to be inaccurate due to the different amounts of resources used by
different product lines at the same company. Plant-wide allocation systems generally fail to
accurately assign costs to different products.
The advantages of the activity-based cost system are that the unit prices calculated from
this method are extremely close to the actual cost of producing the item. Because it breaks down
the costs drivers for each product line, large companies can use this method to accurately
estimate the cost of each product. The only disadvantage is the complexity of calculations.
4.

The biggest issue the South Dakota Microbrewery faces is the negative gross margin of

their Bismark Bock beer. The worries of the owners about the gross margin of the Buffalo Ale
being too low are unfounded, and based on the inaccurate cost breakdowns of the plant-wide
allocation method. Having analyzed the costs using the activity-based cost method, it is clear that
the ale and the stout have gross margins that are higher than the targeted 30% gross margin for
each beer. It is only the bock that is proving to be an issue as far as profitability.
The bock sells at the highest price of the three beers ($1.50 per bottle), and yet still sells
at a loss due to the extremely high costs of producing the beer. While it require less direct labor
hours than the other two beers, and therefore appears to be profitable when only direct labor
hours are used to allocate costs, the bock beer uses more units of each cost-driver except direct
labor and number of bottles than either of the other two beers. Fermentation days, machine
hours, number of orders, and quality control inspections all are extremely high volume
requirements for the bock.
Fermentation days, direct labor hours, and machine hours are fairly difficult to change, as
they are required for the production of the beer no matter what. However, if the number of orders
were reduced, shipping costs, which are currently the highest changeable cost associated with the
bock, could also be reduced. To achieve this goal while still selling all of their beer, the brewery
would need to find more high volume customers. While this would reduce the costs resulting
from the cost driver of number of orders, such a solution could also go against the goals of

reaching a wider audience with the brewerys craft beers, since customers would have fewer
places from where they can purchase the beers.
Another cost driver whose volume could potentially be reduced is the number of bottles
per batch. Each bottle requires filling and labeling costs, and therefore the fewer bottles, the
lower the cost. In order to keep the amount of beer the same, the brewery could have larger
volume bottles, which would thus lower the costs of labeling and filling all of the bottles. Such a
plan may be impractical however, as it could involve extra costs with changing the machinery to
support different bottle sizes.
Finally, the cost driver that seems to be the best solution in reducing the cots of
production for the bock and therefore increasing the gross margin is the number of quality
inspections per batch. The brewery currently has 22 inspections per batch for the bock compared
to 4 and 8 for the ale and stout respectively. While the process of brewing the bock is much more
complicated than the process of brewing the ale or the stout, having 22 inspections per batch
seems excessive.
Based on the facts outlined above, the following changes are recommended. If the
number of inspections could be reduced to 11 inspections per batch, each batch could still have
far more attention than either the ale or the stout, while still reducing costs roughly $24 per
batch. In addition, if the number of orders were halved as well in order to sell higher quantities to
fewer bars and stores, costs would be reduced by another $75 per batch. Such a drop in the
number of orders is reasonable, considering that it would place the number of orders at the same
level as the stout, and still far higher than the ale. With the proposed changes, the gross margin
per batch would increase by $99 to $59.50 per batch, which means a gross margin percentage of
roughly 10%, and a total annual gross margin of $7,140. While not at the 30% goal, it is far
better than the losses that were being incurred before the suggested changes. Given the high costs
of producing the bock, and the tough market conditions, the brewery should lower their
expectations and be satisfied with the 10% margin for the bock, especially considering how high
the gross margins are for their other two beers.
5.

The allocation cost system used does not affect total net income. The total net income

calculated in exhibits 3 and 4 are essentially the same, meaning that the total net income is the
same whether ABC is used or a plant-wide allocation system is used.

EXHIBIT 1

Direct Materials Cosy

Direct Labor Cost
Direct Labor Hours
Overhead rate (116750 [overhead rate] / 7500
[total DL hours]
Manufacturing Overhead (Labor Hours *
Overhead rate)
Total Product Cost per Batch
Expected Yield in Cases
Bottles (24 per case, 24 * expected yield in cases)
Cost per bottle (in dollars)

Based on Direct Labor

Hours
Bismark
Four Heads
Buffalo Ale
Bock
Stout
62.60
88.95
89.55
108.00
72.00
78.00
18.00
12.00
13.00
15.57

15.57

15.57

280.26
450.86
22.00
528.00
0.85

186.84
347.79
16.00
384.00
0.91

202.41
369.96
18.00
432.00
0.86

EXHIBIT 2

Fermentation Days
Direct Labor Hours
Machine Hours
Number of Orders
Number of Quality Control
Inspections
Number of Bottles per Batch
Total Manufacturing Overhead
Cost
Direct Materials Cost
Direct Labor Cost
Total Cost
Number of Bottles
Cost per Bottle

Total
Cost
38,000.0
0
7,500.00
5,500.00
31,250.0
0
10,500.0
0
24,000.0
0

Activitybased
cost
system
Total
Volume

Rate

Buffalo Ale
Activity
Volume

Cost

Bismark Bock
Activity
Volume

2,910.00
7,500.00
82,700.00

13.06
1.00
0.07

3.00
18.00
110.00

39.18
18.00
7.32

14.00
12.00
325.00

3,740.00

8.36

2.00

16.71

4,850.00
229,920.0
0

2.16

5.00

0.10

528.00

Four Heads
Stout
Activity Volume

Cost

4.00
13.00
135.00

52.23
13.00
8.98

18.00

Cost
182.8
2
12.00
21.61
150.4
0

9.00

75.20

10.82

22.00

47.63

8.00

17.32

55.11
147.1
4
62.60
108.0
0
317.7
4
528.0
0
0.60

384.00

40.08
454.5
5
88.95

432.00

45.09
211.8
3
89.55

72.00
615.5
0
384.0
0
1.60

78.00
379.3
8
432.0
0
0.88

EXHIBIT 3

Price per bottle

Number of Bottles
Total Revenue
Total Cost
Gross Margin Per Batch
Gross Margin %
Number of Batches
Total Gross Margin (batches * GM per
batch)

Buffalo
Ale
1.05
528.00
554.40
317.74
236.66
42.69
250.00
59,164.
59

ABC Gross Margin

Calculations
Bismark
Four Heads
Bock
Stout
Total
1.50
1.40
384.00
432.00
576.00
604.80
615.50
379.38
-39.50
225.42
-6.86
37.27
120.00
120.00
-4,739.47

27,050.88

81,476.00

EXHIBIT 4

Price per bottle

Number of Bottles

DL Plantwide Overhead Gross Margin

Calculations
Buffalo Bismark
Ale
Bock
Four Heads Stout
1.05
1.50
1.40
528.00
384.00
432.00

Total Revenue
Total Cost
Gross Margin Per Batch
Gross Margin %
Number of Batches
Total Gross Margin (batches * GM per
batch)

554.40
450.86
103.54
18.68
250.00
25,885.
00

576.00
347.79
228.21
39.62
120.00
27,385.20

604.80
369.96
234.84
38.83
120.00
28,180.80

81,451.0
0