Question

Brent Company's cost system assigns MSDA expenses to customers using a rate of 33% of sales revenue. The new CFO has discovered that Brent's customers differ greatly in their ordering patterns and interaction with Brent's sales force. Because the CFO believes Brent's cost system does not accurately assign MSDA expenses to customers, he developed an ABC system and gathered the following information. Sales Cost of Goods Sold Sales representative travel 1 Service customers Handle customer orders Ship to customers Austin $860,000 440,000 8,000 30,000 2,000 48,000 Brooke $700,000 310,000 84,000 220,000 24,000 144,000 Required: (a) Using the current cost system's approach of assigning MSDA expenses to customers using a rate of 33% of sales revenue, determine the operating profit associated with Austin and with Brooke. (b) Using the activity-based costing information provided, determine the operating profit associated with Austin and with Brooke. (c) Which of the two methods produces more accurate assignments of MSDA expenses to customers? Explain.

Answer 1

(a)

Using the current cost system's approach of assigning MSDA expenses to customers using a rate of 33% of sales revenue, determine the operating profit associated with Austin and with Brooke.

	Austin	Brooke
Sales	$860,000	$700,000
Less: Cost of goods sold	$440,000	$310,000
Less: MSDA (Sales × 33%)	$283,800.00	$231,000.00
Gross profit	$136,200.00	$159,000.00

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(b)

Using the activity-based costing information provided, determine the operating profit associated with Austin and with Brooke.

	Austin	Brooke
Sales	$860,000	$700,000
Less: Cost of goods sold	($440,000)	($310,000)
Gross margin (A)	$420,000	$390,000
Less: MSDA expenses
Sales representative	$8,000	$84,000
Service customer	$30,000	$220,000
Handle customer orders	$2,000	$24,000
Ship to customers	$48,000	$144,000
Total activity expenses (B)	$88,000	$472,000
Operating profit (A-B)	$332,000	($82,000)