Question

Garner Industries manufactures precision tools. The firm uses an activity-based costing system. CEO Deb Garner is very proud of the accuracy of the system in determining product costs. She noticed that since the installment of the ABC system 10 years earlier, the firm had become much more competitive in all aspects of the business and earned an increasing amount of profits every year.

In the last two years, the firm sold 0.523 million units to 4,700 customers each year. The manufacturing cost is $300 per unit. In addition, Garner has determined that the order-filling cost is $48.76 per unit. The $476.00 selling price per unit includes 19% markup to cover administrative costs and profits.

The order-filling cost per unit is determined based on the firm’s costs for order-filling activities. Order-filling capacity can be added in blocks of 60 orders. Each block costs $60,000. In addition, the firm incurs $1,500 order-filling costs per order.

Garner serves two types of customers designated as PC (Preferred Customer) and SC (Small Customer). Each of the 100 PCs buys, on average, 4,000 units in two orders. The firm also sells 123,000 units to 1,000 SCs. On average each SC buys 123 units in 10 orders. Ed Cheap, a buyer for one PC, complains about the high price he is paying. Cheap claims that he has been offered a price of $400 per unit and threatens to take his business elsewhere. Garner does not give in because the $400 price Cheap demands is below cost. Besides, she has recently raised the price to SC to $503.25 per unit and experienced no decline in orders.

Required:

1. Demonstrate how Garner arrives at the $48.76 order-filling cost per unit.

2. What would be the amount of loss (profit) per unit if Garner sells to Cheap at $400 per unit?

3. What is the amount of loss (profit) per unit at the $503.25 selling price per unit for units sold to SC?

Answer 1

a)	Determination of the $ 48.76 order filling cost per unit
Total number of orders			2*100 PC+10*4000 SC	40200
Number of orders per block			60
Total no of blocks			670	(40200/60)
Cost per block			60,000
Total cost of order blocks			4,02,00,000	(670*60,000)
Total no of orders			40200
Per order order filling cost			1500
Total cost per order			6,03,00,000	(40200*1500)
Total order filling cost			10,05,00,000	(4,02,00,000+6,03,00,000)
Total units sold			5,23,000	0.523*10,00,000
Order filling cost per unit			192.16	(10,05,00,000/5,23,000)
b)	Profit margin per unit sold
Total no of orders per year			2
Number of orders per block			60
Total no of blocks			30	(60/2)
Cost per block			60,000
Total block cost			2000	(60,000/30)
Total no of orders			2
Per order order filling cost			1500
Total cost per order			3000	(2*1500)
Total order-filling cost			5000	(2000+3000)
Total units per order			4000
Order filling cost per unit			1.25	(5000/4000)
Net profit per unit at $ 400 Selling price per unit to preferred customers
Selling price per unit			400
Manufacturing cost		300
Order filling cost per unit		1.25
Total cost per unit			301.25	(300+1.25)
Net profit per margin			98.75	(400-301.75)
Profit margin			24.69%	(98.75/400)
3)	Profit margin per unit sold
Total no of orders per year			10
Number of orders per block			60
Total no of blocks			6	(60/10)
Cost per block			60,000
Total block cost			10000	(60,000/6)
Total no of orders			10
Per order order filling cost			1500
Total cost per order			15000	(10*1500)
Total order-filling cost			25000	(10000+25000)
Total units per order			123
Order filling cost per unit			203.25	(25000/123)
Net profit per unit at $ 503.25 Selling price per unit to preferred customers
Selling price per unit			503.25
Manufacturing cost		300
Order filling cost per unit		203.25
Total cost per unit			503.25	(300+203.25)
Net profit per margin			0.00	(503.25-503.25)
Profit margin			0.00%