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 Sales Visits Product modifications Phone calls E-mail/electronic communications Cost Driver Sales visit days Number of modifications Number of minutes Number of communications Total Cost $ 489.000 273,000 93,300 175,000 $1,030,300 Visit Days Customer 625 Revenue $ 403,000 503.000 603.000 1,130.000 1.530.000 54.169.000 Gross Profit $ 153.000 203.000 233,000 423.000 593,000 $1,605,000 25 40 Phone Electronic Modifications Minutes Communications 1. 160 1.250 875 1.500 1.130 1.850 2.130 2.250 2.380 8,010 7.140 90 100 Totals 270 200 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

Solution:

1. Allocating the sales and support costs based on the total revenue

Customer	Gross Profit	Share of Support Costs Based on Revenue	Profit After Support Costs	Profit %
A	153000	99594.84	53405.16	13.25
B	2,03,000	124308.20	78691.80	15.64
C	233000	149021.56	83978.44	13.93
D	423000	279260.97	143739.03	12.72
E	593000	378114.42	214885.58	14.04
Totals	1605000	1030300	574700	13.79

Profit percentage is calculated by dividing profit after support costs by revenue.

2. Activity based costing

Customer	Gross Profit	ABC Costs	Net Profit After Support Costs	Profit %
A	153000	76471.90	76528.10	18.99
B	2,03,000	101758.78	101241.22	20.13
C	233000	172212.43	60787.57	10.08
D	423000	318654.57	104345.43	9.23
E	593000	361202.31	231797.69	15.15
Totals	1605000	1030300	574700	13.79