Zhou vineyards is an independent wine producer located in the Okanagan region. Recently, management took the decision to restrict the product line and specialize in the production of two types of wine: Pinot and Cabernet. The wine is usually produced in batches of 200 bottles. The batch costs are the same to produce the Pinot and the Cabernet.

The following information pertains to Zhou’ production.

Direct Costs per bottle	Pinot	Cabernet
Grapes	$ 3.00	$ 2.20
Bottle & cork	$ 0.65	$ 0.60
Direct Labour	$ 2.20	$ 2.00

Costs that pertain to the production of a batch of wine are listed below:

Costs per batch
Set up Costs of Machinery	$ 140.00
Barrels	$ 450.00
Production Supervisor	$ 100.00

The following costs represents the shared manufacturing costs to produce Cabernet and Pinot:

Production Costs of the Company
Harvesting Costs	$ 600,000
Machinery Depreciation	$ 310,500
Master Sommelier Salary	$ 120,000
Pesticide & Fertilizer	$ 40,000

Currently, Zhou calculates the unit price by tracing the direct costs per bottle and allocating the total manufacturing overhead based on the number of bottles produced per year. This, year, an estimated production of 88,000 bottles of Pinot and 100,000 bottles of Cabernet was used as the allocation base.

The following additional information on the production costs of the company are provided:

• The harvesting costs represent the costs of farming the vines over the course of the year to maximize the production of grapes. This involves mostly manual labour of workers. The harvesting of the vines requires, on average, 40,000 labour hours per year. As the vines of the Pinot are more fragile, they normally require 70% of the total labour hours.
• The machine depreciation represents the total annual depreciation taken for the equipment. The equipment is used for the production of Pinot and Cabernet; however, the production of the Pinot is more complex and normally requires more fermentation time. As a result, the Pinot uses 6,000 machine hours per year while the Cabernet uses 4,000 machine hours per year.
• The Master Sommelier is in charge of ensuring the quality of the wine production. The Master Sommelier estimates that he spends as much time on the quality control of the Pinot as the Cabernet.
• The pesticide and fertilizer are essential to maintaining the health of the vine. The pesticides and fertilizer are spread equally over the 40 acre vineyard. The Cabernet vines occupy 24 acres.
• Management pays $50,000 per year to enter the Pinot in various contests in an effort to win awards and pick-up accolades that can be displayed on the label of the bottle. This cost is specific to the Pinot. Management believes that their Pinot would be at a serious disadvantage if they did not participate in these contests.

Required:

1.            Should Contest costs be allocated as product cost? Explain 

2.            Calculate the cost of a bottle of Pinot and Cabernet using the current costing system.

3.            Calculate the cost of a bottle of Pinot and Cabernet using an Activity Based Costing approach. 

4.            Based on the results obtained above, would you advise Management to apply ABC costing?

5.            If managements decides to implement ABC costing, briefly explain how you believe management should implement this approach.

6.            What are some of the disadvantages of applying Activity Based Costing approach.