1. Assign the customer-related activity costs to each category of customers in p
ID: 2492131 • Letter: 1
Question
1. Assign the customer-related activity costs to each category of customers in proportion to the sales revenue earned by each customer type.
Calculate the profitability of each customer type. (Because sales revenues for each customer type are equal, the profitability will be the same for each customer type.)
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2. Assign the customer-related activity costs to each customer type using activity rates. Enter the appropriate activity rates below.
Calculate the profitability of each customer category.
Sales revenue $ Customer-related activity costs $Explanation / Answer
1.
Sales revenue = $1.05 × 44,100,000 = $46,305,000 for each customer type. (Note: The total number of parts is the average order size times the number of sales orders.) Thus, the total customer-related activity costs are split equally:
Cost allocation = 0.50 × $12,390,000 = $6,195,000
The profitability of each category is calculated as follows:
Sales revenue
$ 46,305,000.00
Less: Noncustomer-related cost ($0.56 × 44,100,000)
$ 24,696,000.00
Customer-related activity costs
$ 6,195,000.00
Customer profitability
$ 15,414,000.00
This profitability measure is suspect because the customer-related costs are assigned using revenues, a driver that is not causally related to the customer-related activity costs. This approach may actually have one set of customers subsidizing the other.
2.
Activity-based customer costing:
First, calculate the activity rates for assigning costs to suppliers:
Processing sales orders: $2,310,000/23,100 = $100 per order
Scheduling production: $1,260,000/42,000 = $30 per scheduling hour
Setting up equipment: $3,780,000/31,500 = $120 per setup
Inspecting batches: $5,040,000/31,500 = $160 per inspection
Next, assign the costs to the customers (those who place frequent orders and those who place infrequent orders):
Frequent
Infrequent
Processing sales orders:
$100 × 21,000
$ 2,100,000
$100 × 2,100
$ 210,000
Scheduling production:
$30 × 36,750
$ 1,102,500
$30 × 5,250
$ 157,500
Setting up equipment:
$120 × 26,250
$ 3,150,000
$120 × 5,250
$ 630,000
Inspecting batches:
$160 × 26,250
$ 4,200,000
$160 × 5,250
$ 840,000
Total customer cost
$ 10,552,500
$ 1,837,500
Profitability:
Frequent
Infrequent
Sales revenue
$ 46,305,000
$ 46,305,000
Less: Other costs
$ 24,696,000
$ 24,696,000
Customer-related costs
$ 10,552,500
$ 1,837,500
Customer profitability
$ 11,056,500
$ 19,771,500
This outcome reveals that customers who place smaller, more frequent orders are not as profitable as believed. To increase profitability of this segment, management may consider the possibility of imposing a charge for orders below a certain size, thus reducing the demands on the four customer-related activities with a subsequent reduction in cost. Another possibility is to offer quantity discounts to encourage larger orders.
Sales revenue
$ 46,305,000.00
Less: Noncustomer-related cost ($0.56 × 44,100,000)
$ 24,696,000.00
Customer-related activity costs
$ 6,195,000.00
Customer profitability
$ 15,414,000.00
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