Question

EXERCISE 7-10 Customer Profitability Analysis LO7-3 LO7-4 .L07-5 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 5%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers. Worley would charge the hospital $105 to purchase these supplies. For years, Worley believed that the 5% markup covered its selling and administrative expenses and provided a reasonable Page 346 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: Total Cost $ 500,000 248,000 Total Activity 5,000 deliveries 4,000 orders 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 12,500 orders 450,000 line items 200,000 450,000 602,000 $2,000,000

Answer 1

1. To calculate the total revenue worley would receive from university and Memorial wells use the following formula ;

Total Revenue = University Revenue + Memorial Revenue

Revenue for University

Cost of Goods Sold = $30,000

Profit Margin ( 5% ) = Cost of Goods Sold * 5% profit margin

Therefore ;

Revenue (University ) = Cost of Goods Sold + Profit Margin ( 5% )

Revenue ( University ) = $ 30,000+($ 30,000 * 5 %)

= $ 31,500

# Revenue for Memorial

Cost of Goods Sold = $ 30,000

Profit Margin ( 5% ) = Cost of Goods Sold * 5%

Revenue = Cost of Goods Sold + Profit Margin 5%

Revenue = $ 30,000 +($ 30,000 * 5 %)

= $30,000 + $1500 = $ 31,500

Total Revenue = University Revenue + Memorial Revenue

= $ 31,500 + $ 31,500

= $63,000

2. Compute the activity rate for each activity cost pool .The activity rate measures the unit cost for each activity carried out .

Activity Rate = Total Cost / Total Activity

​​​​​​we can calculatethe activity rate as follows;

Activity Pool	Total Cost ( TC)	Total Activity (AC)	Activity Rate (TC/TA)
Customer delivers (Number of Deliveries)	$ 500,000	5,000	$ 100
Manual Order processing ( Number of manuel Order )	$ 248,000	4,000	$ 62
Electronic Order Processing ( Number of Electronic Order )	$ 200,000	$ 12,500	$ 16
Line item picking ( Number of line item picked )	$450,000	$ 450,000	$ 1
Other Organization sustaining cost	$ 602,000

According to the above table ;

# The customer delivery activity rate is $ 100 for each activity.

# The order Manuel processing activity rate is $ 62 for each activity.

# The electric order processing activity rate is $ 16 for each activity.

# The line items selection activity rate is $ 1 for each activity.

3. To calculate the total costs of the activity assigned to university and Memorial wells use the following formula.

​​​Total Activity Cost = Activity Cost ( University ) + Activity Cost ( Memorial )

The activity cost for university can be calculated follows :

Activity Cost (University ) = Number of Activities performed * Activity Rate

University	No.of activities performed	Activity Rate	Activity Cost
Number of Deliveries	10	$ 100	$ 1,000
Number of Manual Orders	0	$ 62	0
Number of electric order	15	$ 16	$ 240
Number of line items picked	120	$ 1	$ 120
Activity Cost (University)			$ 1,360

Therefore the activity cost for university = $ 1360

The actualcost for Memories can be calculated as follows; Activity Cost ( Memorial ) = Number of activities performed * Activity Rate

Memorial	No.of activities performed	Activity Rate	Activity Cost
Number of Deliveries	25	100	2500
Number of Manual order	30	62	1860
Number of electronic order	0	16	0
Number of line items picked	250	1	250
Activity Cost ( Memorial )			$ 4,610

There for the activity cost of memorials are $ 4,610.

Applying the formula for the total activity cost ;

Total activity cost = Activity Cost (University ) + Activity Cost ( Memorial )

Total Activity Cost = $ 1360 + $ 4610 = $ 5,970

4. The customer margin for university is as follows

Revenue		$ 31,500
Cost of Goods Sold	$ 30,000
Activity Cost
Number of Deliveries ( 10 deliveries * 100 units )	$ 1,000
Number of Manual order (0 Orders * $62 Units )	0
Number of Electric Order ( 15 Orders *$ 16 Units )	$ 240
Number of line items picked ( 120 like items * $ 1 Units )	$ 120
Total Cost Per activity	$ 1,360	$ 1,360
Customer Margin		$ 140

Customer margin for university is $ 140

The customer margin calculation ( Memorial )

Revenue		$ 31,500
Cost of Goods sold		30000
Activity Cost
Number of Deliveries	$ 2,500
Number of Manual orders	$ 1,860
Number of electric order	0
Number of line liten picked	$ 250
Total Cost Per activity	$ 4610	$ 4610
Customer margin		$ ( 3,110)

Customer Margin for Memorial is $ ( 3,110)