Rice West

APPLICATION OF ABC AND ABSORPTION COSTING
IN A DEVELOPING ECONOMY:
IMPORTING RICE IN WEST AFRICA

Julia E. S. Grant, Assistant Professor, Weatherhood School of Management
Case Western Reserve University, Cleveland, Ohio

Paula Gutman, Sales Representative
Fujitsu-ICL Systems Inc., Cleveland, Ohio

Rice is one of the staple foods in Mali, West Africa; and, happily for this country, most of what is consumed annually, between 72 and 85 %, is grown on the rice paddies along the Niger River. However, a certain amount must be imported every year to make up for the deficit. About 90 % of this importation is done so legally by two or three major importers, one of whose operations is described in the following case.

Mali's role in the world rice market is small; the country imports only 4% of the total rice traded in the world; the average over the past five years is about 60,000 tons. Still, for rice traders in Mali, an extra thousand or two tons in inventory can mean disaster for the trader's bottom line, and too little will mean lost revenues and serious shortages for the population. So making final decisions regarding the future marketability of rice is difficult business, and Amadou Takoure, an executive at one of the largest rice trading companies in Mali, was currently facing this process.

It was 10 a.m. on June 15, 1993, when Takoure, the Chief Financial Officer, was already feeling that the day had stretched too long in this hottest season of the year. He needed to budget rice imports for the year, and this was the season for making difficult importing decisions. Currently prices stood at $610, about $30 above the variable costs of importing rice (half of these variable costs is transportation and customs charges). Prices usually rise in the fall, but by how much depends on the rains and whether demand is rising.

Making the final decision on how much rice to import for arrival on August 15, in time for the fall market, is an exercise in information gathering (calling large rice associations in Segou, Mopti, Baguineda, and Selingue to find out what their harvests may be), historical analysis (looking at the past for any evidence of trends), inventory taking (assessing the total amount of rice in stock currently in the country), psychology (anticipating what the other importers are going to do, as well as what the smugglers are going to smuggle), and star-gazing (trying to anticipate rains and the resulting prices for rice three months from now in a highly unstable economy with several unpredictable factors). He called over his trusted assistant, Dramane Coulibaly, to talk through the company's cost constraints and get some fresh ideas.

Takoure: Dramane, I need to get the right marketing mix among our main products—rice, refrigerators, air conditioners, and tiles—to cover our overhead and realize a profit. I have to say that I am thoroughly frustrated with our inability to bring down our overhead costs, which continue to average about $100,000 a month.

Coulibaly: Well, you know, we have the electric company, which seems to enjoy it enormously when we turn on a bit of air conditioning. And at $10 per minute for the boss's overseas calls, no wonder our phone bill is so huge. Plus we have those huge interest payments on the financing of our imports. It won't help to complain— we just need to get the right product mix to cover it. And, as you know, part of covering the overhead is deciding on a reasonable allocation system. You know that we have been using your system for a few quarters, where we allocate based on relative sales dollars, but we never predict accurately what sales will be. We really need to be sure that we are at least trying to get prices adequate to cover all the costs.

Takoure: You're right. We need to determine an allocation base that reflects our biggest headache, which is getting our merchandise sold as quickly as possible. Our tiles languish in the warehouse for an average of six months, our air conditioners for as long as four months, and our refrigerators as much as three months. Currently our variable costs on tiles per ton are about $12,016; on air conditioners, per unit about $418; and on refrigerators per unit, about $582.

Coulibaly: Did I tell you that interest rates have just gone up 50 basis points to 18%? You know this means that the longer our goods stay in those warehouses, the more we pay in interest, which is part of our overhead. I know we have very favorable arrangements at the bank where principal is due 120 days after the merchandise lands. Still since we are borrowing 100 percent of our variable costs, the faster we can sell, the faster we can pay the principal.

Takoure. By the way, what are we paying for our new warehouse?

Coulibaly: The warehouse for the durable goods costs $1,500 per month, and can hold 30,000 cubic feet of merchandise. I asked our warehouse supervisor to tell me how much of each item we can fit into the place. He told me that the refrigerators take up about thirty cubic feet, the air conditioners require five, and each ton of tiles requires about fifty. Oh, and each ton of rice takes up one hundred cubic feet in a grain warehouse. And you may want to know that the price of each of those 560,000 cubic foot grain warehouses, available as we need them, just doubled to one cent per cubic foot.

Takoure: OK. According to my market calculations, during this season we can import, store, and eventually sell 600 refrigerators, 1,000 air conditioners, and 15 tons of tiles. I estimate prices on these will be about $720, $600, and $18,000. Before I can make a decision on rice imports, I am going to have to do a little inventory study on current rice stocks in the country, and call around to the rice associations. Rains have begun to fall and though it is probably too early to tell, some of these farmers are pretty good at predicting the harvest for December anyway. We need to make a decision by this afternoon on the total we will import.

After calling the associations, he determined that the harvest would probably increase from last year (rains have been good so far), and there would be at least 270,000 tons harvested in the 1993-94 season. [See Exhibit A.] If total consumption continued to rise, as it had over the past four years, an average of 13.7% annually, then the consumption for 1994 would be 378,000 tons. If contraband imports returned to the 36,000 ton level (a conservative estimate), then the total deficit would be 68,000 tons. This company traditionally had a large share of the rice import market, about 40%, so Takoure figured that he should import at least 27,000 tons. Right now he can buy rice at $580 per ton, including the cost of transportation and customs duty; and it would arrive on August 15. He expected that prices would rise, even with a good harvest, because of rising demand. He wanted to sell the first sacks of rice by mid-September for about $635 per ton, and he hoped to raise prices by I % for each of the months of October and November. Takoure expected that he would have to reduce prices to $630 in December during the harvest, and he hoped to have sold at least 26,000 tons by the New Year. He wondered if fully absorbed costs would be covered by these prices.

He began work on a spreadsheet that he would finish after lunch. He hoped by the time he met with his boss he would have an overhead allocation method which made sense.

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