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PRODUCT COSTING REPORT Addressing Costing issues in the Organisation May 2018 Word Count- 3261

CONTENTS Executive Summary………………………………………………………………………………………………………….3 Part 1 – Business Processes 1.1 Value Chain Diagram…………………………………………………………………………………………………4 1.2 Value Chain Analysis………………………………………………………………………………………………….5 Part 2 – Product Costing System Design 2.1 Outline of ABC and how it differs from Traditional costing systems…………………………7 2.2 Outline of Benefits and Disadvantages of ABC…………………………………………………………8 2.3 Product Costing System for Red Wine based on ABC………………………………………………8 2.3.1 Direct and Indirect Product Costs……………………………………………………………………8 2.3.2 Activity Cost Pools…………………………………………………………………………………………..9 2.3.3 Activity Cost Drivers………………………………………………………………………………………10 2.3.4 Cost Hierarchy……………………………………………………………………………………………….11 Part 3 – Product Costing System Application 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9

Direct Materials……………………………………………………………………………………………………..12 Direct Labour………………………………………………………………………………………………………….12 Overhead Cost Pools……………………………………………………………………………………………….13 Overhead Activity Cost Drivers………………………………………………………………………………..13 Percentage of overhead allocation………………………………………………………………………….13 Allocation of Overhead Costs…………………………………………………………………………………..14 Activity Cost Rates…………………………………………………………………………………………………..14 Overhead Costs estimated to Manufacture Wynns Coonawarra Shiraz…………………..14 Total Product Cost…………………………………………………………………………………………………..15

Reference List………………………………………………………………………………………………………………..16 Appendix……………………………………………………………………………………………………………………….19

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EXECUTIVE SUMMARY The CFO of TWE has tasked the team to prepare a report to address product costing issues in the organization. In This report we aim to analyze TWE’s Value Chain, design a product costing system for wine manufacturing based on ABC and apply it to cost TWE’s Wynns Coonawarra Shiraz. The report consists of 3 parts. Part 1 contains Value Chain Analysis. This section outlines the upstream activities, Operations (Winemaking) and downstream activities. This information was sourced from TWE Annual Report 2017. In Part 2 we have outlined Activity based Costing System, how it differs from traditional costing systems, its pros and cons and designed a product costing system to cost wine manufacturing based on ABC highlighting its key benefits and disadvantages. Various sources were cited and wine manufacturing activities were assessed to compile this section. It also consists of Direct & Indirect Product costs attributed to Materials, Labor and Overheads. Relevant activity Cost pools & Cost drivers have been outlined and a Cost Hierarchy for Cost Pools is also presented in Part 2. In Part 3, we have applied the Product costing to cost Wynns Coonawarra Shiraz. In this section we have estimated Direct Material, Direct Labor and all relevant Overhead costs using Activity Based Costing system. This information was utilized to estimate Total product of a bottle of wine and evaluate a selling price. After careful consideration of information available on hand, we safely conclude that Activity-Based Costing systems benefits companies with huge overhead bases and various production processes producing multiple types of product lines. ABC is also beneficial for performance management purposes and can be integrated with and used alongside other systems within an organization. TWE has a diverse range of products where inappropriate decision making could be costly. The organization has a robust IT system, sufficient enough to implement and maintain ABC. It is recommended for TWE to implement ABC to allocate Overhead costs for its product range. Even though the Overhead costs are not significant in the case of TWE (owing to huge production volume), implementing ABC will improve decision making which will convey efficiencies in all activities of the Value Chain. Although ABC is more expensive than traditional approaches, it brings about considerable benefits about more accurate decision making in the highly competitive environment.

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Grapes Sourcing & Growing (Inbound Logistics)

•TWE has a diversified sourcing model through which fluctuations in raw material prices and consumer behaviour is mitigated. TWE harvests & sources its grapes from company owned and grower vineyards. TWE produces 77% & 97% of its wine in Australia & New Zealand respectively. TWE sources 67%, 77% and 100% of wine from third party winemakers in California, Italy and France respectively. •TWE supplements annual intakes and manages input costs by sourcing aditional wine from countries such as South Africa, Chile and Argentina.

Wine making (Operations)

•TWE owns its wine production and packaging facilities. In Australia & New Zealand TWE owns & operates 9 wineries in SA, VIC and in Marlborough. •Wine manufacturing process consists of several stages- Sorting and Crushing Grapes, Fermentation, Ageing and bottling. •Grapes are moved from warehouse to sorting to crushing where must is collected and fermented. The wine is then transferred into barres for ageing. •Upon reaching its optimum age wine is tested for quality and bottled.

Marketing & Sales

•TWE’s major sales are focus on national retail chains, independent retailers and on premise outlet. There is little proportion of wine sold to large distributors. •TWE is establishing global IT systems which would provide more comprehensive information about customer behaviors to formulate various marketing strategies to attract broader range of customers •TWE’s products are sold through retailers, having complete understanding of different patterns of customers and forging positively strong relationship with their distribution partners

Distribution

•TWE outsources the services provided by Trebuchet Logistics to deliver its products to national retailer, on premise outlet and exporters in Australia •Trebuchet Logistics uses the fourth party logistics (4PL) methods to manage and transit TWE’s products to local retailer, outlets and exporters •4PL refers to a method consolidating the efforts of third party providers, consulting company and technology providers to manage time, place utilities and control possession utilities of client organizations

Service

•TWE has developed a high-trained customer service team throughout the international business. Because valuable customers are critical components to maintain business' stable growth, the empolyees of this department aim to provide real-time responses to customers' problems. •TWE has dedicated significant resources to train its team and maintain high service levels.

1.1 VALUE CHAIN DIAGRAM 4 | PRODUCT COSTING REPORT MAY 18

1 .2 Value Chain Analysis This section provides a detailed analysis of Treasury Wine Estates’ Value Chain, outlining primary activities which are classified into Grapes growing and sourcing, Wine making, Marketing and Sales, Distribution, and Customer service (TWE 2017). Grape Growing and Sourcing TWE sources its raw materials (grapes) and some finished goods from company owned, Leased and grower vineyards and from third party produced wine market. In Australia and New Zealand, TWE produces 77% and 97% of its wine respectively with grapes supplied by grower and company owned and leased vineyards. The other 23% of its wine is sourced via third party winemakers. In contrast, TWE only produces 33%, 23% and 0% of its wine in California, Italy and France respectively. TWE sources 67%, 77% and 100% of wine from third party winemakers in California, Italy and France respectively. By way of a diversified sourcing model, TWE manages its price risk concerning raw materials and any changes in consumer behaviour (TWE 2017). Wine making (Operations) Sorting Grapes

Crushing Graps

Fermentation

Ageing

Bottling

The operations of value chain refer to the activity of transforming inputs into finished products or services (CSCMP & Sanders 2014). TWE owns a considerable number of wineries and packaging facilities for wine manufacturing across the globe (Treasury Wine Estates 2017). The process of producing red wine is described as per following:o

Sorting Grapes

The first step in the process of manufacturing wine is picking up grapes from storage warehouse and sorting the grapes ready for crushing. Sorting of grapes can be done by hand. Bins or big boxes are used to collect grapes and transferred to crushing belt. (Myers 2018) o

Crushing Grapes

In de-stemming, de-stemmer is used to remove the stems from the batch and delicately crush grapes (Wine Folly 2018). As grapes has been transferred to the next step, they are ready to get crushed and de-stemmed. 5 | PRODUCT COSTING REPORT MAY 18

o

Fermentation

This step transforms sugar into alcohol. There are variety of processes applied during this stage. After the fermentation is completed, grapes are pressed. To Clear up the wine, the red wine will spend considerable time maturing in the barrels (Wine Folly 2018). o

Ageing

When it comes to aging, winemakers have many options and it depends on the type of wine manufactured. Flavours in wine become more profound based on wine making methods. For example, aging for years or months, using stainless steel or oak based barrel etc. (Wine Folly 2018). o

Bottling the wine

Bottling the wine is the final step. Wine is bottled by machines. Here the winemaker has two choices: Bottling up the wine at this stage or give more aging time. The additional ageing can be performed in bottles, or in tanks or barrels. When winemakers believe that wine has reached its full flavour and consistency,

its

sent

for

distribution

(Myers

2018).

Marketing and sales TWE’s major sales are focus on national retail chains, independent retailers and on-premise outlet. There is little proportion of wine sold to large distributors. TWE promotes its product through highly localized business campaign. TWE is establishing global IT systems which would provide more comprehensive information about customer behaviours to formulate various marketing strategies to attract broader range of customers, such as advertising its branded wine associated with sport events. Because wine industry is intensively competitive and most of TWE’s products are sold through retailers, having complete understanding of different patterns of customers and forging positively strong relationship with their distribution partners are the important components for maintaining healthy sales. Distribution TWE outsources distribution to Trebuchet Logistics to deliver its products within Australia. Trebuchet Logistics uses the fourth party logistics (4PL) methods to manage and transit TWE’s products to local retailer, outlets and exporters (Bowling 2012). 4PL refers to a method consolidating the efforts of third party providers, consulting company and technology providers to manage time, place utilities and control possession utilities of client organizations (Win 2018).

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Customer Service TWE has a dedicated team providing customer service. The staffs of this department always stand by to deal with customers’ problems. Because TWE considers customers as important resource for their business growth, it invests significantly on training its customer services teams. TWE solves customers problems efficiently and effectively. 2.1 Outline of ABC and how it differs from Traditional costing systems Activity based costing system has been deemed as one of the best accounting innovations (Bjornenak & Mitchell 1999). ABC is defined as an economic model used to measure the cost and efficiency of the task performed and cost objects (Turney 1996). Process control data is provided by ABC (Innes and Mitchell 1990). Table 1 – Difference between ABC and Traditional Costing System Activity Based Costing Traditional Costing To find cost Depends on the activity performed,

To find cost It requires cost objects and the

by cost object

resources used are required.

More Accurate allocation of overheads

Less Accurate allocation of overheads

Usually applied When overheads are significant, Usually applied when Overheads are less and organization has multiple products. Multiple overhead pools are used

Single overhead pool

Highly complex (Cooper, R., 1990)

Simple (Cooper, R., 1990)

Decision

making

becomes

simpler,

and N/A

management has a better understanding. Focus on the activity instead of structure

Its center around the structure instead of process.

(Difference Between ABC and Traditional Costing 2018)

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2.2 Outline of Benefits and Disadvantages of ABC Table 2 – Benefits and Disadvantages of ABC Benefits of ABC

Disadvantages of ABC

Accurate allocation of OH costs associated with Product/Service

Implementing ABC in a Project based task that needs significant resources

Allows Cost estimation of processes and value chain flows

ABC can be very complex and information can be misinterpreted

Allows for a better understanding of activities and their cost drivers

Managers familiar with Traditional Costing system which are less expensive

Can be used to manage performance

Since ABC is used for Internal making decision making its reports cannot be used by external stakeholders. A separate system is needed to prepare external reports.

Better integration with other systems allowing for continuous improvement

ABC is process intensive and expensive to maintain

Key Benefit of ABC- Accurately allocates overheads costs to Products/Services Key Disadvantage of ABC- ABC is a complex system that is process intensive and expensive to implement and maintain (Cokins & CĂPUŞNEANU 2011). 2.3 Product Costing System for Red Wine based on ABC 2.3.1 Direct and Indirect Product Costs Direct Product Costs are attributable to the following: Direct Materials: The following materials are considered direct materials as these are direct inputs to Wine manufacturing: o

Grapes

o

Yeasts

o

Sugar

o

Bottles

o

Corks

Direct Labour Although the production processes in crushing, destemming and bottling relies on a considerable base of machinery, it still needs some employees to operate and monitor this equipment. In aging process, it relies on wine makers’ decision to determine if the wine is ready to be packaged or still needs to be

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matured. In fermentation, employees mix specific proportion of sugar, yeasts and grape juice together (Wine Folly 2018). These workers are directly related to production and would be classified as direct labours. Indirect Product Costs are attributable to the following: o

Insurance

TWE owns considerable amount of PPE. The organisation pays insurance in order to prevent and safeguard those assets (TWE 2017). This cost is hard to trace to each product. o

Utilities

Many of the production processes rely on a huge base of machine, such as destemming and packaging. This equipment consumes significant amount of electricity and water to produce wine. Utility cost is one of manufacturing overhead because it is difficult to trace to each product. o

Depreciation

Due to the huge base of equipment, properties, and plant, the depreciation cost should be considered into its product cost to decide the product price. The depreciation rate applied annually to plants and equipment is from 3.3% to 40% (TWE 2017). This cost is not directly related to the production of wine and should be one of the overhead cost. o

Equipment maintenance

In order to prevent the damage caused by the machinery shut down, the equipment in the production regularly takes preventive inspections and maintenances (Treasury Wine Estate 2017). o

Rent

Some of the vineyards TWE used to grow its grapes are leased from others and this company also pays for some leasehold buildings (Treasury Wine Estate 2017). Because it is hard to measure how much amount of rent each product used, this cost can be one of indirect cost. 2.3.2 Activity Cost Pools The following activities are the key activities in the process of manufacturing wine. Hence the activity cost pools have been designed based on the following activities: Material handling Grapes are moved from warehouse to sorting facilities. This is considered material handling since direct material is being manually moved and sorted. Crushing and destemming In this step, grapes are removed from their stems and crushed by de-stemmer which are the machines used to destem grapes (Wine Folly 2018).

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Fermentation and ageing After grapes are crushed wine makers add yeasts and sugar into grape juice and put it into barrels. The barrels filled with juice are placed for a period of time to mature. The sugar is transformed to alcohol in this process (Wine Folly 2018). Quality Control When wine is ready, it is just one step away from getting into the bottle and that is quality check. This task is performed as TWE produces world class wine. This helps the company to make sure desired quality of wine is achieved. Bottling When wine is aged for a period of time and ready to be served, wine is bottled from the barrels into Wine bottle by machines. After wine is bottled, wine makers determine to age these wines for more time in bottle or put them into sales as preferred (Wine Folly 2018). 2.3.3 Activity Cost Drivers *Assumption: For the purpose of this report we are buying grapes from third-party suppliers Number of Grape deliveries After grapes are harvested and collected into bins or boxes and then delivered, these batches of materials are transferred to sorting facilities. Therefore, the activity cost of material handling could be assigned by the number of grapes delivery from every vineyards to crushing and destemming process. Number of machine hours In the crushing and destemming process, grapes are removed from their stems and pressed into juice by machines. As the result, the activity driver in this process could be the number of machine hours because it relies on huge operation of machine. Number of barrels After grape juice is mixed with specific proportion of yeasts and sugar, it is put into barrels and placed to mature which makes the sugar transform into alcohol. Because the wine is place in number of barrels, the level of activity in fermentation and aging could be determined by how much barrel are used to contain grape juice. Number of bottling machining hours When wine are matured for a period of time and ready to be packaged, wine are bottled and labelled through the series of process operated by machine. Consequently, the activity cost of bottling could be allocated by the number of machine hours consumed by each product. 2.3.4 Cost Hierarchy

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Table 3 – Cost Hierarchy Activity Cost Pools

Cost Driver

Cost Hierarchy

Material handling

No of grapes delivered

Product Level/Batch Level

Crushing and Destemming

No of Machine Hours

Batch Level

Fermentation and aging

No of Barrels

Batch Level

Quality Check

No of inspection

Ba...