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ABSTRACT: This case examines an actual dairy's pricing decision for a sizeable order from a major customer. The purpose is to encourage students to consider the complexities of pricing decisions and the role of managerial accounting information in these decisions. Specific managerial accounting concepts addressed include product costing, selection of an appropriate allocation base, accounting for opportunity costs, relevant or incremental analysis, strategic cost management, and activity-based costing. The case highlights the importance of designing an appropriate costing system to support strategic pricing and product mix decisions by demonstrating how poor cost information can encourage decisions that run contrary to a firm's strategy.
BACKGROUND
Quality Dairy is a large milk processing company located in Ohio with sales of about $100,000,000 per year. Founded in 1890, Quality remained a small, privately held company until 1960. At that time, Quality was purchased by the regional milk cooperative which is owned and operated by and for dairy farmers. Quality's primary role in the cooperative is to provide an outlet for all surplus milk produced by member farmers. The U.S. government supports the price of milk by guaranteeing to purchase unlimited amounts of butter, powdered milk and cheese at set prices. Thus, Quality provides the means by which cooperative members ensure that they receive full price for all milk produced.
Any skim milk or cream that Quality is unable to use in products sold to commercial customers is either converted into nonfat dry milk and sold to the government or sold to a creamery. Although sales of surplus milk products to the government and the creamery are not profitable, Quality is able to remain moderately profitable due to its commercial business. Net income averages $1,000,000 per year and return on equity is about ten percent. Most of Quality's profits come from its mix business and sales of condensed skim and nonfat powdered milk. The condensed and powdered milk is sold to other dairies and food processors in truck-load quantities.
The dairy industry is plagued by a constant surplus of butterfat which is churned into butter and sold to the U.S. government at a loss. As a result, Quality sells its surplus butterfat to a creamery for $.20 per pound of butterfat less than its direct costs (milk cost...