Question

Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 7%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $107 to purchase these supplies. For years, Worley believed that the 7% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits, Worley decided to implement an activity-based costing system to help improve its understanding of customer profitability. The company broke its selling and administrative expenses into five activities as shown: Activity Cost Pool (Activity Measure) Customer deliveries (Number of deliveries) Manual order processing Number of manual orders) Electronic order processing (Number of electronic orders) Line item picking (Number of line items picked) Other organization-sustaining costs (None) Total selling and administrative expenses Total Cost $ 498,000 365,000 364,000 1,032,000 650,000 $2,909,000 Total Activity 6,000 deliveries 5,000 orders 14,000 orders 480,000 line items Worley gathered the data below for two of the many hospitals that it serves-University and Memorial (each hospital purchased medical supplies that had cost Worley $34,000 to buy from manufacturers): 29 Activity Measure Number of deliveries Number of manual orders Number of electronic orders Number of line items picked Activity University Memorial 15 0 46 16 0 160 240

Answer 1

(1) Total Revenue received

	University	Memorial
Cost of goods sold to hospital	$34,000	$34,000
Mark up percentage	7%	7%
Markup in dollars	$2,380($34,000*7%)	$2,380(34,000*7%)
Revenue	$36,380($34,000+$2,380)	$36,380

(2) Activity rate =estimated overhead /expected activity

Activity cost pool	estimated overhead cost	Expected activity	Activity rate
customer deliveries	$498,000	6000 deliveries	$83 per delivery	($498,000/6000)
manual order processing	$365,000	5,000 orders	$73 per order	($365,000/5,000)
electronic order processing	$364,000	14,000 orders	$26 per order	($364,000/14000)
Line item packing	$1,032,000	480,000 line items	$2.15 per line item	($1,032,000/480,000)

(3) Total activity costs

UNIVERSITY	Activity rate	ACTIVITY	Cost
customer deliveries	$83 per delivery	15	$1,245	($83*15)
manual order processing	$73 per order	0	$0	($73*0)
electronic order processing	$26 per order	16	$416	($26*16)
Line item packing	$2.15 per line item	160	$344	($2.15*160)
	Total activity cost		$2,005	(1245+416+344)

MEMORIAL	Activity rate	ACTIVITY	Cost
customer deliveries	$83 per delivery	29	$2,407	($83*29)
manual order processing	$73 per order	46	$3,358	($73*46)
electronic order processing	$26 per order	0	$0	($26*16)
Line item packing	$2.15 per line item	240	$516	($2.15*240)
	TOTAL ACTIVITY COST		$6,281	(2407+3358+516)

(4)CUSTOMER MARGIN

	University	memorial
Revenue	$36,380	$36,380
cost of goods sold	$34,000	$34,000
Less:overhead cost allocated	$2,005	$6,281
Customer margin	$375(36,380-34,000-2,005)	$3,901(36,380-34,000-6,281)