Merando Corporation produces two grades of wine from grapes that it buys from California growers. It produces and sells roughly 600,000 gallon jugs per year of a low-cost, high-volume product called Valley Fresh. Merando also produces and sells roughly 200,000 gallons per year of a low-volume, high-cost product called Merando Valley. Merando Valley is sold in 1-liter bottles. Based on recent data, the Valley Fresh product has not been as profitable as Merando Valley. Management is considering dropping the inexpensive Valley Fresh line so it can focus more attention on the Merando Valley product. The Merando Valley product already demands considerably more attention than the Valley Fresh line.

Frankie Merando, president and founder of Merando, is skeptical about this idea. He points out that for many decades the company produced only the Valley Fresh line, and that it was always quite profitable. It wasn’t until the company started producing the more complicated Merando Valley wine that the profitability of Valley Fresh declined. Prior to the introduction of Merando Valley, the company had simple equipment, simple growing and production procedures, and virtually no need for quality control. Because Merando Valley is bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and box, than does Valley Fresh. The company must bottle and handle 4 times as many bottles of Merando Valley to sell the same quantity as Valley Fresh, since there are approximately 4 liters in a gallon. Valley Fresh requires 1 month of aging; Merando Valley requires 1 year. Valley Fresh requires cleaning and inspection of equipment every 2,500 gallons; Merando Valley requires such maintenance every 250 gallons. Frankie has asked the accounting department to prepare an analysis of the cost per gallon using the traditional costing approach and using activity-based costing. The following information was collected.

Â	Â	Â	Â	Expected Use of Cost Drivers per Product
Activity Cost Pool	Cost Driver	Estimated Overhead	Expected Use of Cost Drivers	Valley Fresh	Merando Valley
Grape processing	Cart of grapes	$ 146,000	8,000	6,000	2,000
Aging	Total months	420,000	3,000,000	600,000	2,400,000
Bottling and	Number of	Â	Â	Â	Â
corking	bottles	210,000	1,400,000	600,000	800,000
Labeling and	Number of	Â	Â	Â	Â
boxing	bottles	140,000	1,400,000	600,000	800,000
Maintain and	Number of	Â	Â	Â	Â
inspect equipment	inspections	234,000	1,040	240	800
Â	Â	$1,150,000	Â	Â	Â

Instructions

Answer each of the following questions. (Round all calculations to three decimal places.)

(a) Under traditional product costing using direct labor hours, compute the total manufacturing cost per gallonof both products.

(b) Under ABC, prepare a schedule showing the computation of the activity-based overhead rates (per cost driver).

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product, based on the use of cost drivers. Include a computation of overhead cost per gallon.

(d) Compute the total manufacturing cost per gallon for both products under ABC.

(e) Write a memo to Frankie Merando discussing the implications of your analysis for the company’s plans. In this memo, provide a brief description of ABC as well as an explanation of how the traditional approach can result in distortions.