Family Food Distributor (FFD) distributes products to grocery stores. The company began operation sixth months ago with...
Family Food Distributor (FFD) distributes products to grocery stores. The company began operation sixth months ago with three major customers: Seven Eleven, Family Mart and Wellcome. For the latest month, FFD has the following customer profitability report:
|
Seven |
Family |
|||
|
Eleven |
Mart |
Wellcome |
Total |
|
|
Revenues |
$45,000 |
$63,000 |
$52,000 |
$160,000 |
|
Costs of goods sold |
31,500 |
44,100 |
36,400 |
112,000 |
|
Gross profit |
13,500 |
18,900 |
15,600 |
48,000 |
|
Store support |
15,000 |
15,000 |
15,000 |
45,000 |
|
Customer profit margin |
(1,500) |
3,900 |
600 |
$3,000 |
The store support costs totaling $45,000 were equally allocated to each customer.
Similar monthly results have been reported since the first month in operation. Connie Chang, the president of FFD, has been wondering about the report above. She is not convinced that the amount of customer profit margin as shown on the report was accurately calculated. Particularly, she feels that charging store support cost equally to each customer does not present an accurate picture of customer profitability.
At a recent seminar on management, Connie learned about ABC (activity-based costing) and thought this new accounting measurement technique might give her a better picture of the company’s profitability. Consequently, she directed the company’s controller to conduct an ABC analysis on store support costs. After a few weeks of long working hours, the controller identifies four activities that make up store support: ordering, delivery of merchandise, shelf-stocking and customer assistance. He further gathers the following data relating to the $45,000 of support cost that is shown in the above report:
|
Monthly |
Activity |
Monthly |
|
|
Activity |
support cost |
driver |
quantity |
|
Ordering |
$ 9,500 |
Number of purchase orders |
95 |
|
Delivery of merchandise |
14,800 |
Number of deliveries |
185 |
|
Shelf-stocking |
9,720 |
Hours of shelf-stocking |
486 |
|
Customer assistance |
10,980 |
Number of items delivered |
54,900 |
|
Total store support cost |
$45,000 |
The controller further identifies the amount of activities associated with the three customers as follows:
|
Seven |
Family |
|||
|
Eleven |
Mart |
Welcome |
Total |
|
|
Number of purchase orders |
50 |
25 |
20 |
95 |
|
Number of deliveries |
120 |
35 |
30 |
85 |
|
Hours of shelf-stocking |
240 |
150 |
96 |
486 |
|
Number of items delivered |
20,000 |
25,000 |
9,900 |
54,900 |
Required
- Calculate the cost per unit of each activity driver.
- Prepare a revised customer profitability report for FFD based on the ABC system.
- Based on the results you obtained in Requirements 1 and 2, what would you recommend to Connie in order to improve FFD’s profitability?
- Briefly describe the advantages of the activity-based costing system over the old costing system of FFD.
Homework Answers
Answer 1:
Answer 2:
First let us allocate support cost based on ABC:
Answer 3:
When support costs are allocated based on ABC, we observe that loss on sales to Customer 'Seven Eleven' is higher at ($9,900).
To improve FFD's profitability:
FFD should further analyze, sales /costs to 'Seven Eleven'. FFD should look into reasons and take appropriate action to eliminate losses like reduce cost or increase sale price or discontinue.
Answer 4:
Advantages of the activity-based costing system over the old costing system of FFD:
1. Old system of allocating support cost equally to customers does not have any basis defining cause and effect relationship . Activity based costing (ABC) method determines the activity cost pools, cost drivers (based on what drives those costs establishing a cause and effect relationship), calculates activity rates and then allocates costs.
2. Traditional methods is not rational whereas ABC method has rational
3. The internal stakeholders who uses these cost data, will understand cost allocation done based on ABC better and can take specific actions. Cost data based on traditional method lacks such analysis and does not help in taking any specific actions to control overhead costs.
4. Cost data based on ABC are much more precise than cost data based on traditional method. As such it results in better decisions. Cost data based on traditional methods may result in erroneous decisions impacting the future of business.
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The excel sheet (with above 3 tables) with 'show formula' is as below:
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