Forest Hill Paper Company Case Study

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The cost for Forest Hill to do a grade change is $11,750. The total cost of a grade change ($47,000) divided by the total number of grade changes (4) gives us the cost for a grade change for each reel.

The cost for Forest Hill to slit a reel of paperboard is $2,294.12. Only Grades A and C are normally slit, which means there is only 85 reels that will be used in calculations. The total slitting cost ($195,000) divided by the number of reels that get slit (85) gives us $2,294.12 to slit one reel.

The new volume-based overhead rate after removing the grade change costs and the slitting costs is 91%. The total direct costs drop from $1,828,470 to $1,586,470 which in turn, lowers the overhead rate due to a lower numerator.

If we want to look at Forest Hill’s cost a different way (activity-based), then we have to look at the activity costs associated with each grade. The activity based costs for each grade are as follows:

Product Grade

Material Cost Per Reel

Overhead Cost Per Reel (91% of Material Cost)

Number of Reels

Grade Change Costs

Slitting Cost

Total Cost Per Reel (ABC)

A

$4,800

$4,368

50

$235.00

$2,294.12

$11,697.12

B

$5,200

$4,732

2

$5,875.00

$-

$15,807.00

C

$5,600

$5,096

35

$335.71

$2,294.12

$13,325.83

D

$7,400

$6,734

175

$67.14

$-

$14,201.14

In order to know how volume-based and activity-based costs stack up against each other, we have to compare them. The different in costs between the two costing systems (both dollar amount and percent change) are shown below.

Product Grade

Total Cost Per Reel (Volume-Based)

Total Cost Per Reel (Activity-Based)

Difference

Percent Change

A

$9,840

$11,697.12

$(1,857.12)

-18.9%

B

$10,660

$15,807.00

$(5,147.00)

-48.3%

C

$11,480

$13,325.83

$(1,845.83)

-16.1%

D

$15,170

$14,201.14

$968.86

6.4%

There is a clear difference in the total cost per reel using the two costing systems. By using their traditional costing system, they could be applying overhead to products that don’t actually cause any of those costs. This means that the system would be inaccurate and could be showing costs higher or lower than a more accurate system would account for.

By using the activity-based costing system, Forest Hill can more accurately assign costs. The overhead rate is lower (91% versus 105%) because there is more specific costing per activity (reel) and takes into account that some activities may not use a cost driver that a different one might. This allows Forest Hill to more accurately track costs and allows them to add and remove costs when needed based on what a certain product grade calls for.

Forest Hill’s current system does not do as good of a job as the activity-based system on accounting for their wide product lines and the different costs that are associated with them. By switching, Forest Hill can more accurately represent the costs that they have with each different product and help them more accurately track costs. Due to the fact that the industry is very cyclical, a volume-based costing system would seem to increase the costs when busy even though per activity (reel), the costs would stay the same. This would help keep any inflated costs accounted for and keep their costing consistent no matter how many orders they are receiving.

In addition, Forest Hill needs to assess their product offerings and see which products are making them money and which aren’t and streamline their offerings. With the new activity-based costing system, Forest Hill can more accurately look at the per-reel cost and compare it to their current prices to see where they have been potentially losing money. For example:

Product Grade

Total Cost Per Reel (Activity-Based)

Selling Price

Profit

A

$11,697.12

$12,600

$902.88

B

$15,807.00

$13,500