Question

Question 4: Best company supplies furniture to three local retailers, Danny, Penner, and Victor Inc. The following exhibit presents representative revenues and costs of Best by customers for the year 2019. Additional information on Best's costs for different activities at various levels of the cost hierarchy is as follows: Danny S540,000 370,000 47,000 Penner $340,000 220,000 20,000 Victor $450,000 380,000 37,000 Total $1,330,000 $970,000 $104,000 Sales Cost of goods sold Materials-handling labour Materials-handling equipment (Cost written off as amortization) Rent Marketing support Purchase orders and delivery processing General administration Total operating costs Operating income 10,000 14,000 12,000 13,000 20,000 486,000 $54,000 6,000 8,000 9,000 7,000 12,000 282,000 $58,000 8,000 14,000 11,000 12,000 16,000 478,000 -$28,000 $24,000 $36,000 $32,000 $32,000 $48,000 $1,246,000 584,000 Materials-handing labour costs vary with the number of units of furniture shipped to customers. 2. Different areas of the warehouse stock furniture for different customers Materials-handling equipment in an area and amortization costs on the equipment are identified with individual customer accounts. Any equipment not used remains idle. The equipment has a one-year useful life and zero disposal price, 3. Best allocates rent to each customer account on the basis of the amount of warehouse space occupied by the products to be shipped to that customer 4. Marketing costs vary with the number of sales visits made to customers SI Purchase order costs vary with the number of purchase orders received: delivery processing costs vary with the number of shipments made 6 Best allocates fixed general administration costs to customers on the basis of dollar sales made to each customer

Answer 1

1 Note: Only variable cost are relevant in decision making Fixed costs are sunk cost and not relevant for decision making Sales Relevant revenue Cost of goods sold Relevant costs Materials-handling labor costs Relevant costs Marketing support Relevant costs Purchase order and delivery processing Relevant costs Material handling equipment Relevant costs Variable costs Variable costs Variable costs Variable costs Avoidable cost 2 Operating Income if Victor is dropped $82,000 Evaluation of continue or discontinue Customer Existing $1,330,000 Discontinue Differential Victor Inc. Analysis $880,000 -$450,000 Sales Variable expenses: Cost of goods sold Material handling labor costs Marketing support Purchase order and delivery processing Total variable expenses Contribution margin Fixed cost: Material handling equipment Rent General Administration Total Fixed cost Net Operating Income $970,000 $104,000 $32,000 $32,000 $1,138,000 $192,000 $590,000 $67,000 $21,000 $20,000 $698,000 $182,000 -$380,000 -$37,000 -$11,000 -$12,000 $440,000 -$10,000 $24,000 $36,000 $48,000 $108,000 $84,000 $16,000 $36,000 $48,000 $100,000 $82,000 -$8,000 $0 $0 -$8,000 -$2,000 3 Victor Inc. should be retained as Customer since there is drop in net operating income if dropped The contribution margin is higher than avoidable fixed cost hence dropping customer is unprofitable Common fixed cost are irrelevant cost in decision making since they are sunk cost The customer should be dropped only if contribution margin is lower than avoidable fixed cost