BuyGasCo Corporation, Case Study Example

Q1. Why do you believe the judge chose the plaintiff’s costing approach over the defendant’s?

The judge chose the plaintiff’s costing approach over the defendant because he assumed indirect costs to be variable costs that vary directly with the level of sales activity where as the defendant classified the same indirect costs as fixed costs irrespective of sales level. The judge may have concluded that since regular gasoline was outselling others so most of the indirect costs were occurring in selling the regular gasoline. This would mean that if regular gasoline sales were lower than the current level, they would incur lower indirect costs, thus, reducing the total indirect costs in the process, too. It is also possible that judge’s final decision might have been influenced by existing industry practices, too where most of the gasoline producers allocate indirect costs to individual products on the basis of sales volume generated by them.

Q2. Explain why Dr. Humboldt’s analysis included the cost of a hypothetical “kiosk”.

Humboldt used ABC that seeks to identify activities whose direct contribution towards a particular product can be established and are also known as cost drivers. BuyGasCo sells its products through convenience stores that also sell other products. Gasoline happens to be one of the many products being sold at the convenience stores. Thus, not all activities taking place at the convenience stores contribute towards gasoline sale or add any value to it. This means many of the indirect costs incurring at the convenience stores are irrelevant to the act of selling gasoline. Dr. Humboldt assumed a scenario where the only product being sold is gasoline. He concluded that a kiosk is all that would be sufficient to sell gasoline.

Q3. Explain how the costs in the case behave with respect to the following cost hierarchy: unit level, batch-level, product level, and organization level, including specific examples of each hierarchy level.

Unit level cost would be cost of raw materials which in this case is gasoline. Unit level costs are direct costs that stay same per unit at all production and sales levels. Batch-level cost would be delivery trucks that transport batches of each gasoline product line. Product-level costs are gasoline storage and dispensing assets such as gas pumps. If kiosks are built, unlike convenience stores they would also be product level cost for as long as they only sell gas. Convenience stores come under organization level costs. Organization level also includes salaries of sales associates that also sell other products such as soda and snacks etc. besides gasoline at BuyGasCo’s owned convenience stores. Another example of organization level costs would be housing attendants at the convenience stores. BuyGasCo signs and lighting fixtures are also organization level costs.

Q4. Explain why Dr. Humboldt’s ABC analysis yields a result between the extremes of the two other costing approaches that had been used in the earlier court hearing.

Humboldt’s ABC analysis yielded a result between the extremes of the two other costing approaches that had been used in the earlier court hearing. Instead of taking a simplified approach towards indirect costs by classifying all of them as fixed costs like defendants did or classifying all of them as variable costs like prosecutors did, Dr. Humboldt classified each indirect cost on a case-by-case basis. As a result, he found that some components of the indirect costs varied with sales levels such as holding tanks and plumbing equipment while others were fixed in nature irrespective of sales levels such as M=P dispensers and Electrical Equipment. So he divided fixed costs equally between three gasoline types while allocated variable indirect costs on the basis of sales volume. This middle ground approach by Dr. Humboldt may explain why arrived at calculations between the extremes of the other two costing approaches.

Q5. To what extent do Dr. Humboldt’s calculations represent an application of ABC, based upon your understanding of ABC? Please explain.

Humboldt did a pretty good job because ABC seeks to identify cost drivers so that it can more accurately determine the nature of cost drivers as to whether they are variable, fixed, or semi-variable. ABC also seeks to find out whether an activity adds value to a product’s production or sale process and thus, minimizing the potential of cross subsidization. In the process, it gives management a more accurate idea of the profitability of individual product lines.

Dr. Humboldt attempted to identify what exactly would be required if the company were to sell gas only. This way he could identify activities taking place at the convenience stores that contributed nothing towards supporting gas sales and for those that did, his approach helped him in identifying their exact cost nature as well as their approximate contribution. This approach is consistent with the intention behind ABC approach.

Q6. Explain whether you think the judge should lift the injunction on BuyGasCo, following consideration of Dr. Humboldt’s ABC analysis.

The judge should lift the injunction on BuyGasCo, following consideration of Dr. Humboldt’s because Dr. Humboldt has succeeded in establishing more accurate relationship between various cost drivers and the gasoline product lines instead of taking a simplified and convenient approach taken by the Florida State AAG and BuyGasCo’s lawyer. Moreover, only regular gasoline was found to be selling below cost by the prosecutor and even though Dr. Humboldt’s method supports BuyGasCo’s original position but it would still force BuyGasCo to raise the prices of its regular gasoline, thus, addressing the prosecutor’s concerns to some extent. Dr. Humboldt analysis is also more detailed and instead of using hypothetical assumptions, seeks to support its rationale through detailed cost analysis.