Question

Ellie Mosk, CEO of X-Space Industries, decided to expand the company’s product offering beyond the core model rocket business. After investigation, she decided to set up a separate division to design and manufacture products for the drone market. Several companies were interested in having X-Space develop these drones, and financial results, to date, have been encouraging. Revenue was $4 million, gross margins have been running about 40%, and the customer sales and support costs were $1 million. However, there is a growing concern that some customers require a disproportionate share of the sales and support resources, and the true profitability of the customers is unknown. Data were collected to support an analysis of customer profitability:

Activity	Cost Driver	Total Cost
Sales visits	Sales visit days	$	480,000
Product modifications	Number of modifications		266,000
Phone calls	Number of minutes		92,600
E-mail/electronic communications	Number of communications		168,000
		$	1,006,600

Customer	Revenue				Gross Profit				Visit Days				Modifications				Phone Minutes				Electronic Communications
A	$	394,000			$	144,000				15				15				1,090				625
B		494,000				194,000				25				15				1,180				875
C		594,000				224,000				40				40				1,430				1,060
D		1,060,000				414,000				90				60				1,780				2,060
E		1,440,000				584,000				100				70				2,180				2,310
Totals	$	3,982,000			$	1,560,000				270				200				7,660				6,930

Required:

1. Management felt the easiest way to allocate the sales and support costs was based on the total revenue. Using total revenue as the allocation base, determine the profitability of each of the five customers.

2. Management felt that because the data revealed some customers require a disproportionate share of sales and support resources, activity-based costing should be used to determine customer profitability. Use ABC to prepare a customer profitability analysis.

Answer 1

(1): Here the total support costs of $1,006,600 will be allocated on the basis of total revenue. So the amount to be allocated per $ of revenue will be = 1,006,600/3,982,000 = 0.252788

So the amount allocated to customer A will be = $394,000*0.252788 = 99,598.29. In the same manner we can allocate the total support cost to other customers by multiplying their revenue with 0.252788

	i	ii	iii	iv = ii - iii
Customer	Revenue	Gross profit	Support costs	Profit = gross profit - support costs
A	394,000	144,000	99,598.29	44,401.71
B	494,000	194,000	124,877.05	69,122.95
C	594,000	224,000	150,155.80	73,844.20
D	1,060,000	414,000	267,954.80	146,045.20
E	1,440,000	584,000	364,014.06	219,985.94
Total	3,982,000	1,560,000	1,006,600.00	553,400.00

(2): Here we will compute the cost base for each activity. Take the activity of sales visits. Here the cost is $480,000 and the cost driver is sales visit days. Total sales visit days = 270. Thus cost per visit = 480,000/270 = 1,777.78. Thus cost of $480,000 that will be allocated to customer A will be = 480,000/270*15 = $26,666.67. In the same manner we will use the total of cost driver activities and compute cost for each customer.

	i	ii	iii	iv	v	vi	vii = ii-iii-iv-v-vi
Customer	Revenue	Gross profit	Sales visit costs	Product modification cost	Phone calls cost	e-mail costs	Profit = gross profit - sum of all support costs
A	394,000	144,000	26,666.67	19,950	13,176.76	15,151.52	69,055.06
B	494,000	194,000	44,444.44	19,950	14,264.75	21,212.12	94,128.68
C	594,000	224,000	71,111.11	53,200	17,286.95	25,696.97	56,704.97
D	1,060,000	414,000	160,000.00	79,800	21,518.02	49,939.39	102,742.59
E	1,440,000	584,000	177,777.78	93,100	26,353.52	56,000.00	230,768.70
Total	3,982,000	1,560,000	480,000	266,000	92,600	168,000	553,400