Case Summary:

In this case study, Ace Fertilizers Assistant Director of Manufacturing, Abby Conroy, is
faced with an ethical dilemma presented by her direct manager George Smilee, Director
of Manufacturing. Ace Fertilizers Principal business is production of lawn & gardening
fertilizer, however the company has a proven record of delivering high quality, on-time
products in the special orders market. Its the quality and on-time production that drives
this area of the business. They use a consistent billing formula for special orders at an
80% markup over the cost of the orders.
Abby Conroy prefers allocating indirect costs using Activity-Based Costing for these
orders, recognizing that not all costs are driven by volume of output. Abby is preparing a
cost estimate for Breeland Ltd., a company that has requested a special order for a
solvent whose ingredients include 40 gallons of a chemical called XO-1600. The
chemical XO-1600 is only available in 50-gallon drums and has a shelf-life of only 20 days
once opened. After 20 days, the substance becomes unstable and must be discarded
properly. Breeland Ltd. does not wish to keep the unused gallons.
The following is her cost estimate:
Direct Materials
Non-XO-1600

$20,000

XO-1600 Purchase Cost

$80,000

Disposal Cost
Direct Labor

$10,000
$30,000

Unit-level Activity Cost ($40 * 4,000 gallons)

$160,000

Batch-level Activity Cost ($5000 * 4 batches)

$20,000

Product-level Activity Cost

$80,000

Customer-level Activity Cost

$30,000

Organization-sustaining level Activity cost

(20,000+80,000+10,000+30,000+160,000+20,000)

$320,000

Total Cost of Breeland Ltd Special Order

$750,000

Markup on cost ($750000/.80)

$900,000

Total Price Determination for Breeland Ltd. order

$1,650,000

Since Breeland Ltd only needs 40 gallons of XO-1600, they do not wish to keep the
unused gallons and no other orders are confirmed that uses this substance, Aces
estimate includes a $10,000 disposal cost for the remainder.
At a family weekend get-together, George Smilee makes an unconfirmed deal with his
brother Josh to purchase the unused gallons of XO-1600 for Joshs company. In
consideration of this, Abby wants to ask Breeland Ltd for more time to deliver the

estimate, so that she can rework the cost allocations to reflect the appropriate billing for
only what Breeland Ltds order will be using. George asks her not to do this, citing the
ability to bill the 10 gallons of XO-1600 to Breeland Ltd. and Joshs company. The
$10,000 disposal cost would not be incurred by Ace, however it would remain on the
estimate for Breeland Ltd. This would add $93,600 (with markup) to Aces bottom line,
helping to 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:
Abbys cost estimate was flawed due to an error in the markup figure. Rather than
multiplying the total costs for the order by .80, she divided by .80. The cost estimate
with correct markup should be:
Direct Materials
Non-XO-1600

$20,000

XO-1600 Purchase Cost

$80,000

Disposal Cost
Direct Labor

$10,000
$30,000

Unit-level Activity Cost ($40 * 4,000 gallons)

$160,000

Batch-level Activity Cost ($5000 * 4 batches)

$20,000

Product-level Activity Cost

$80,000

Customer-level Activity Cost

$30,000

Organization-sustaining level Activity cost

(20,000+80,000+10,000+30,000+160,000+20,000)

$320,000

Total Cost of Breeland Ltd Special Order

$750,000

Markup on cost ($750000*.80)

$600,000

Total Price Determination for Breeland Ltd. order

$1,350,000

Question 2.
Whose assessment of the costing of this special order do you believe is correct George
Smilees or Abby Conroys? That is, should Georges conversations with Josh impact
Abbys cost estimate of the Breeland Ltd. special order?
Answer:
Provided the correction is made to the markup, Abbys assessment would be the correct
estimate. In accordance with company policy, Abby includes billing the full cost of the
orders materials, assuming there will be unused portions. However, once there is an
order for remaining unused materials, disposal is no longer a cost to Ace Fertilizer, and

therefore does not need to be passed on to the customer. Furthermore, the cost of the
XO-1600 itself can be allocated accordingly between the two cost estimates. Georges
assessment includes double billing for a single material cost, as well as a disposal fee,
which is not needed, in order to inflate the bottom line.
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:
The ethical issues are, as stated above, double billing for a single cost and not removing
unnecessary costs (disposal) from an estimate in order to inflate profits. It may also be
conflicting interests to do so when one customer is family of the Director of
Manufacturing. Abbys decision to revise the order is the ethical approach. According to
the IMA guide, Abby should contact the next higher-up, Tom Brennen. Since Tom is the
Chief Operating Officer and ultimately has to sign off on orders before they are finalized,
he should be made aware of the pending order for the remaining XO-1600.
Question 4.
If Abby were to modify her original cost estimate of the Breeland Ltd. special order to
include Joshs 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
Fertilizers bottom line?
Answer:
The following is a revised cost estimate:
Direct Materials
Non-XO-1600

$20,000

XO-1600 Purchase Cost (80,000 * 40/50)

$64,000

Disposal Cost
Direct Labor

$0
$30,000

Unit-level Activity Cost ($40 * 4,000 gallons)

$160,000

Batch-level Activity Cost ($5000 * 4 batches)

$20,000

Product-level Activity Cost

$80,000

Customer-level Activity Cost

$30,000

Organization-sustaining level Activity cost

(20,000+64,000+10,000+30,000+160,000+20,000)

$294,000

Total Cost of Breeland Ltd Special Order

$698,000

Markup on cost ($698000*.80)

$558,400

Total Price Determination for Breeland Ltd. order

$1,256,400

Total of Abby's Original Cost

Estimate:
Total adjusted cost estimate
Difference

$1,650,000
$1,256,400
$393,600

Total of corrected original cost

estimate:
Total adjusted cost estimate
Difference

$1,350,000
$1,256,400
$93,600

Ace Fertilizers bottom line is reduced with the modified estimate, however it reflects a
professional and ethical price determination, making their products more valuable to
current and future customers. This strengthens the integrity of their operation.
In conclusion, it may serve Ace Fertilizer Company well to implement a second person to
approve final orders for purposes of greater internal controls. I would also review the
companys definition of conflict of interests to ensure favors are not given to certain
orders at the expense of other customers.