Question

0 function? P5-14 ACTIVITY-BASE OFITABILAN e company is has shown Jans to Wa CTIVITY-BASED COSTING AND PRODUCT LINE PRO "Percor is a grocery company with stores throughout Spain. Suppose the ning an expansion of its store in central Madrid. A preliminary analysis Ickaged Food department to be the most profitable, so the company plane space the most. Assume that the Madrid store has just three departments: Produce. Part at. The most recent annual report for the store showed sales of €3,283,200. a gross margin of €883,200. Sales and gross margins of the three departments w backaged Food 200, which gener s were as Produce Packaged Food Meat Total Revenues Cost of products sold Gross margin €634,800 480,000 €154,800 €1,680,480 1,200,000 €480,480 €967,920 720,000 €247,920 €3,283,200 2,400,000 €883.200 osts, so operating accounting system ar on activity-based maddition to cost of products sold, the store has €720,000 of support costs, so income is €883,200 - €720,000 = €163.200. Hipercor currently uses an accounti that uses cost of products sold as a cost-allocation base for allocating support costs. Ramon Flores, controller of Hipercor, recently attended a seminar on activi costing. He suggests that Hipercor management should undertake further analysis deciding which product gets the largest increase in space in the expansion. He has asked his assistant, to lead this analysis. 1. The starting point of your analysis is to determine product profitability under the ing cost accounting system. Compute the operating income and the operating income a percentage of sales for each department using Hipercor's existing system. Use this information to assess the relative profitability per dollar of sales of each of the thres departments. 2. Flores asks you next to develop product costs using an activity-based accounting system. You determine that there are five major activities, each with a different cost driver to be used as a cost-allocation base: a) Ordering-Placing orders for purchases b) Delivery--Physical delivery and receipt of merchandise c) Shelf-stocking-Stocking of merchandise on store shelves, including ongoing restocking d) Customer support-Assistance to customers, including checkout and bagging

Answer 1

(1): Support costs being allocated on the basis of % of costs of products sold:

		Produce	Packaged food	Meat	Total
	Revenues	634,800	1,680,480	967,920	3,283,200
	less: Cost of products sold	480,000	1,200,000	720,000	2,400,000
i	Gross margin	154,800	480,480	247,920	883,200
	Cost of products sold for each department as a % of total cost of products sold	20%	50%	30%	100%
ii	less: Allocation of support costs on the basis of above computed %	144,000	360,000	216,000	720,000
iii = i - ii	Operating income = gross margin - support costs	10,800	120,480	31,920	163,200
	Operating income as a % of sales	1.70%	7.17%	3.30%	4.97%

(2): Here let us first allocate the support costs to each department on the basis of cost drivers. So ordering cost that will be allocated to the produce department = 1440/6240 * 124800 = 28,800. In the same manner it will be done for others using the formula: no. of activity for the department/total no. of activities * total cost of that activity

	Produce	Packaged food	Meat	Total
Ordering	28,800	67,200	28,800	124,800
Delivery	19,200	140,160	42,240	201,600
Shelf stocking	8,640	86,400	43,200	138,240
Customer support	20,160	176,640	48,960	245,760
Product monitoring	9,600			9,600
Total	86,400	470,400	163,200	720,000

On this basis the operating income is computed below:

	Produce	Packaged food	Meat	Total
Revenues	634,800	1,680,480	967,920	3,283,200
less:Cost of products sold	480,000	1,200,000	720,000	2,400,000
Gross margin	154,800	480,480	247,920	883,200
less: allocated support costs	86,400	470,400	163,200	720,000
Operating income	68,400	10,080	84,720	163,200
Operating income as a % of sales	10.78%	0.60%	8.75%	4.97%

3. On the basis of the information available we can see that expansion should be focused on the "produce" segment as it has the highest operating margin. The packaged food department is not very profitable so not too much focus should be given to it during expansion.