The current costing strategy implemented in your company is not maximizing your ability to determine profitability of each product due to the incorrect cost allocation. You are currently using the strategy of “peanut butter” costing to assign costs to your current product line. Peanut butter costing is when you take the total costs of your products, in this case overhead, and spread them across your entire product line evenly. When you use this strategy, you can end up over allocating costs to some products and under allocating costs to others. By implementing a more effective costing strategy, you can accurately assign costs to each product based on activity levels and additional costs that are unique to each product. With your current costing system, you are assigning slitting costs to products that aren’t slit, and you are averaging the grade changes equally, which is ineffective in determining the correct prices and costs assigned to each product. After analyzing your books, per unit we found that Product A is currently making a profit of $898, Product B has a loss of $2,300, Product C has a profit of $868, and Product D has a profit of $5,291. As you can see above, there is a remarkable difference between the four products’ profitability once costs are correctly allocated, which causes problems for Forest Hill Paper Company. Some of those problems include pricing, production, warehouse capacity, and profitability. Incorrectly allocating costs to each product affects every aspect of your business and ultimately hurts the bottom line.

Volume Based Costing Explained:
Your current application of overhead prices is to take 105% multiplied by the direct materials cost of each product, which is not the most accurate way to assign costs. This overhead rate takes in to account both grade changes and slitting costs; you cannot spread these costs across