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 $ 481,000 265, 000 92,500 167, 000 $1,005, 500 Customer А B с D E Totals Revenue $ 395,000 495, 000 595, 000 1,050,000 1, 450,000 $3,985, 000 Gross Profit $ 145,000 195,000 225,000 415, 000 585, 000 $1,565, 000 Visit Days 15 25 40 90 100 270 Modifications 15 15 40 60 70 200 Phone Minutes 1,080 1, 170 1, 420 1, 770 2, 170 7,610 Electronic Communications 625 875 1,050 2,050 2, 300 6, 900

Answer 1

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1) Cost allocation based on revenue

Allocation rate= 1005500/3985000=0.25232

Customer	Gross profit	Share of Support Cost Based on Revenue (revenue*0.25232)	Profit After support Costs	Profit % (on revenue)
A	$145,000	99666.88	$45,333	11.48
B	$195,000	124899	$70,101	14.16
C	$225,000	150131.1	$74,869	12.58
D	$415,000	264937.3	$150,063	14.29
E	$585,000	365865.7	$219,134	15.11
Totals	$1,565,000	1005500	$559,500

Cost allocation ratio (A:B:C:D:E) =395:495:595:1050:1450

2) Cost allocation based on ABC (Activity Based Costing)

Calculation of allocation base

Activity	Cost Driver	Total Cost (Col 1)	No of activity (Col 2)	Cost per activity (Col 1 / Col 2)
Sales visits	Sales visit days	481000	270	1781.481
Product modifications	Number of modifications	265000	200	1325
Phone calls	Number of minutes	92500	7610	12.15506
E-mail/electronic communications	Number of communications	167000	6900	24.2029

Allocation of cost base of activity

Activity	Activity base usage	A (Activity Based usage*ABC rate)	Activity base usage	B (Activity Based usage*ABC rate)	Activity base usage	C (Activity Based usage*ABC rate)	Activity base usage	D (Activity Based usage*ABC rate)	Activity base usage	E (Activity Based usage*ABC rate)
Sales visits	15	26722.2222	25	44537.037	40	71259.2593	90	160333.333	100	178148.1
Product modifications	15	19875	15	19875	40	53000	60	79500	70	92750
Phone calls	1080	13127.4639	1170	14221.4192	1420	17260.184	1770	21514.4547	2170	26376.48
E-mail/electronic communications	625	15126.8116	875	21177.5362	1050	25413.0435	2050	49615.942	2300	55666.67
Total		74851.4977		99810.9925		166932.487		310963.73		352941.3

Customer	Gross profit	ABC Costs	Profit after support costs	Profit % (Expressed as a % of Revenue)
A	$145,000	74851.4977	$70,149	17.76
B	$195,000	99810.9925	$95,189	19.23
C	$225,000	166932.487	$58,068	9.76
D	$415,000	310963.73	$104,036	9.91
E	$585,000	352941.3	$232,059	16.00
Totals	$1,565,000	1005500	$559,500	14.04