Friendly Grocer has three departments in its store: beverages, dairy and meats, and cann...

Friendly Grocer has three departments in its store: beverages, dairy and meats, and canned and packaged foods. Each department is headed by a departmental manager. Operating results for the last month (in thousands) are given in the table.

The direct costs consist of the cost of goods sold. Indirect costs consist of selling, general, and administrative (SG&A) costs and are allocated to each department at the rate of 20 percent of costs of goods sold. Based on the preceding report, beverages had operating income of $10,000, dairy and meats had operating income of $75,200, and canned and packaged foods lost $12,400.

Senior management is concerned that the allocation of costs might be distorting the relative profitability of the three departments. Further analysis of the SG&A account yields the following breakdown:

Shelf space costs consist of store occupancy costs such as depreciation on the building and fixtures, utilities, store maintenance, property taxes, and insurance. Beverages make up 25 percent of the shelf space, dairy and meats make up 35 percent of the space, and canned and packaged goods make up 40 percent of the shelf space. Handling costs consist of the labor required to stock the shelves and remove outdated products. The beverage suppliers (Coca-Cola, Pepsi, etc.) provide the labor to shelve their products (i.e., the beverage delivery people stock their products on the shelf). Dairy and meats’ labor costs for stocking are three-quarters of the handling costs; canned and package foods’ labor and handling costs are one-quarter of the total. Coupon costs consist of the labor costs to process the redeemed coupons. Dairy and meats do not have any coupons. Twenty percent of the coupons redeemed are for beverages and 80 percent are for packaged and canned foods. Shrinkage consists of the cost of products spoiled, broken, and stolen. Shrinkage by product category comes to

The remaining indirect costs are allocated based on cost of goods sold.

Required:

a. Apply an activity-based costing system and recalculate the operating income of the three departments.

b. Based on the statement you prepared in part (a), write a short memo to management discussing the revised operating income of the three departments and which statement (yours or the one in the question) management should use.