Pahros Company buys surgical supplies from a variety of manufacturers and the resells and delivers these supplies to hundreds of hospitals. Cleanwater sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 5%. For years the company believed that 5% mark-up covered its selling and administrative expenses and provided reasonable profit. However, in the face of declining profits, the company decided to implement activity-based costing system to help improve its understanding of customer profitability. The company broke its selling and administrative expenses into five activities as shown below: Activity Cost Pool Activity Driver Total Cost Total Activity Customer Deliveries Number of Deliveries $ 500,000 5,000 deliveries Manual order processing Number of manual orders $ 248,000 4,000 orders Electronic order processing Number of electronic orders $ 200,000 12,500 orders Line item picking Number of Line item picked $ 450,000 450,000 line items Other organization - sustaining cost None $ 602,000 Total selling and administrative expense $ 2,000,000 The company gathered the data below for two of the many hospitals that it serves – University and Memorial. Sales revenue generated from University Hospital is $15,000 and from Memorial Hospital $16,000. Activity Driver University Memorial Number of deliveries 10 25 Number of manual orders 0 30 Number of electronic orders 15 0 Number of line item picked 120 250 Required: How much is the customer margin generated by each of the two hospitals. Give your analysis based on your result. Describe the purchasing behaviours that are likely to characterize the least profitable customers. Give your recommendation to the management regarding these two customers in the future. Give your recommendation to the management to be able to increase the profitability of the company’s business.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Pahros Company buys surgical supplies from a variety of manufacturers and the resells and delivers these supplies to hundreds of hospitals. Cleanwater sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 5%. For years the company believed that 5% mark-up covered its selling and administrative expenses and provided reasonable profit. However, in the face of declining profits, the company decided to implement activity-based costing system to help improve its understanding of customer profitability.

The company broke its selling and administrative expenses into five activities as shown below:

Activity Cost Pool	Activity Driver	Total Cost	Total Activity
Customer Deliveries	Number of Deliveries	$ 500,000	5,000 deliveries
Manual order processing	Number of manual orders	$ 248,000	4,000 orders
Electronic order processing	Number of electronic orders	$ 200,000	12,500 orders
Line item picking	Number of Line item picked	$ 450,000	450,000 line items
Other organization - sustaining cost	None	$ 602,000
Total selling and administrative expense		$ 2,000,000

The company gathered the data below for two of the many hospitals that it serves – University and Memorial. Sales revenue generated from University Hospital is $15,000 and from Memorial Hospital $16,000.

Activity Driver	University	Memorial
Number of deliveries	10	25
Number of manual orders	0	30
Number of electronic orders	15	0
Number of line item picked	120	250

Required:

How much is the customer margin generated by each of the two hospitals. Give your analysis based on your result.
Describe the purchasing behaviours that are likely to characterize the least profitable customers.
Give your recommendation to the management regarding these two customers in the future.
Give your recommendation to the management to be able to increase the profitability of the company’s business.

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