Question

Supermart Food Stores (SFS) has experienced net operating losses in its frozen food products line in the last few periods. Management believes that the store can improve its profitability if SFS discontinues frozen foods. The operating results from the most recent period are: Frozen Foods Baked Goods Fresh Produce Sales $ 148,000 $ 142,000 $ 211,000 Cost of goods sold 128,000 104,000 153,000 SFS estimates that store support expenses, in total, are approximately 14% of revenues. The controller says that not every sales dollar requires or uses the same amount of store support activities. A preliminary analysis reveals store support activities for these three product lines are: Activity (cost driver) Frozen Foods Baked Goods Fresh Produce Order processing (number of purchase orders) 10 49 93 Receiving (number of deliveries) 11 73 146 Shelf-stocking (number of hours per delivery) 5 0.5 6 Customer support (total units sold) 22,000 34,000 68,000 The controller estimates activity-cost rates for each activity as follows: Order processing $ 83 per purchase order Receiving 106 per delivery Shelf-stocking

12.00 per hour Customer support 0.21 per item Required: 1. Prepare a product-line profitability report for SFS under the current costing system. 2. Prepare a product-line profitability report for SFS using the ABC information the controller provides.

Answer 1

1. Product-line profitability report for SFS under the current costing system
	Frozen Food	Baked Goods	Fresh Produce
Sales	$148,000	$142,000	$211,000
Cost of goods sold	$1,28,000	1,04,000	1,53,000
Gross margin	$20,000	$38,000	$58,000
Store support (14% of Sales)	20,720	19,880	29,540
Operating income	($ 720)	$ 18,120	$ 28,460
Operating margin (Operating Income/Sales)	-0.48%	12.76%	13.49%

2. Product-line profitability report for SFS under ABC
	Frozen Food	Baked Goods	Fresh Produce
Sales	$148,000	$142,000	$211,000
Cost of goods sold	$1,28,000	1,04,000	1,53,000
Gross margin (Sales - Cost of goods sold)	$20,000	$38,000	$58,000
Store support:
(1) Order processing ($83 times Number of Purchase orders)	830	4,067	7,719
(2) Receiving ($106 times Number of Deliveries)	1,166	7,738	15,476
(3) Shelf-stocking ($12 * Number of Hours * Number of deliveries)	660	438	10,512
(4) Customer support ($0.21 times Total units sold for Customer support)	4,620	7,140	14,280
Total store support cost (1+2+3+4)	7,276	19,383	47,987
Operating income (Gross Margin - Total Store support cost)	$ 12,724	$ 18,617	$ 10,013
Operating margin (Operating Income/Sales)	8.59%	13.11%	4.75%

It can be observed that there is a huge drop in profitability for Fresh products under ABC method when compared to the current cost method. Fresh products require more supporting activities than Frozen food and Baked goods.