Java Source, Inc. Java Source, Inc. (JSI) is a small, Michigan-based processor and distributor of a variety of blends of coffee. The company buys coffee beans from around the world and roasts, blends, and packages them for resale. JSI offers a large variety of different coffees that it sells to gourmet shops in one-pound bags. The major cost of the coffee is raw materials. However, the companys predominantly automated roasting, blending, and packing processes require a substantial amount of manufacturing overhead. Although the production process started out in the early 1990s as a largely labor-intensive operation, the gradual switch to automation meant that currently, the company uses relatively little direct labor. The different blends produced by JSI require varying amounts of time in the roasting and blending processes. The coffee industry in the US is very competitive, with large players in the market (such as Starbucks and Green Mountain Coffee Roasters) marketing and selling several varieties of coffee beans. To differentiate itself from the competition, JSI specializes in many unique luxury blends of coffee. Some of JSIs coffees are very popular and sell in large volumes, while a few of the newer blends sell in very low volumes. JSI prices its coffees at manufacturing cost plus a markup of 25%; however, because consumers of coffee beans are quite price-sensitive, JSI occasionally makes some adjustments to its cost- plus pricing scheme to keep the companys prices competitive. For the coming year, JSIs budget includes estimated manufacturing overhead cost of $2,200,000. JSI assigns manufacturing overhead to products on the basis of direct labor-hours. The expected direct labor cost totals $600,000, which represents 50,000 hours of direct labor time. Based on the sales budget and expected raw materials costs, the company expects to purchase and use $5,000,000 of raw materials (mostly coffee beans) during the year. The expected costs for direct materials and direct labor for one-pound bags of two of the companys coffee products appear below: Kenya Dark Viet Select Direct materials................................................. $4.50 $2.90 Direct labor (0.02 hours per bag) ...................... $0.24 $0.24 Kenya Dark competes directly with several dark blends of other producers. JSIs marketing manager, Charles Bialetti, has noticed that competitors have been continuously lowering prices of their respective dark roasts. The average prices of other dark roasts are hovering around $6.40, almost 10 percent less than current prices. Charles is worried about the viability of Kenya Dark, whose profitability is already in question. Since the JSI plant is already operating at 95% of capacity, Charles is considering the proposal to eliminate the product in favor of other blends, such as Viet Select, a product recently introduced by JSI that has few direct competitors.

Required: 1. Describe the industry in which JSI operates and its role in that industry. What does JSI sell? To whom does it sell its products? How many different blends does Java offer? 2. JSI incurs a substantial amount of manufacturing overhead. Why is this? Be specific. Think about what you have learned about manufacturing overhead in this course. 3. Using JSIs traditional costing system, calculate the per unit product cost and gross margin for one pound of the Kenya Dark and one pound of the Viet Select coffees. This would be similar to when we applied the manufacturing overhead based on a traditional cost driver (i.e. direct labor hours). JSIs controller believes that the companys traditional costing system may be providing misleading cost information. To determine whether or not this is correct, the controller has prepared an analysis of the years expected manufacturing overhead costs, as shown in the following table: Expected Activity Expected Cost Activity Cost Pool Activity Measure for the Year for the Year Purchasing..................................... Purchase orders 2,000 orders $ 560,000 Material handling .......................... Number of setups 1,000 setups 193,000 Quality control .............................. Number of batches 500 batches 90,000 Roasting ........................................ Roasting hours 95,000 roasting hours 1,045,000 Blending........................................ Blending hours 32,000 blending hours 192,000 Packaging...................................... Packaging hours 24,000 packaging hours 120,000 Total manufacturing overhead ...... $ 2,200,000 Data regarding the expected production of the specific coffee blends of Kenya Dark and Viet Select are presented below. Expected sales ........................................ 80,000 pounds 4,000 pounds Batch size ............................................... 5,000 pounds 500 pounds Setups ..................................................... 2 per batch 2 per batch Purchase order size ................................. 20,000 pounds 500 pounds Roasting time per 100 pounds ................ 1.5 roasting hours 1.5 roasting hours Blending time per 100 pounds................ 0.5 blending hours 0.5 blending hours Packaging time per 100 pounds.............. 0.3 packaging hours 0.3 packaging hours 4. Determine the per unit product cost and gross margin for one pound of Kenya Dark coffee and one pound of Viet Select coffee under the proposed activity-based costing system. 5. Describe the two blends of coffee with which we are working in this case. Be as specific as possible. How many units of each blend do we produce and sell? In what batch volume is each blend produced? How many batches of each blend are produced? 6. Given your answers in (3) through (5), prepare a memo addressed to Charles Bialetti. In the memo, provide recommendations to help improve the profitability at JSI. Be as concrete as possible and note both the benefits and costs of the alternatives you propose. 7. Discuss briefly how the use of activity-based costing affects the current and future operating income. 8. The plant managers at JSI have requested the use of transaction drivers (number of times a process is completed) instead of the duration drivers for some activities mentioned above. Would you agree with this proposal? Explain briefly.