Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 5%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $105 to purchase these supplies. For years, Worley believed that the 5% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits, Worley decided to implement an 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: Activity Cost Pool (Activity Measure) 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 items picked) 450,000 450,000 line items Other organization-sustaining costs (None) 602,000 Total selling and administrative expenses $ 2,000,000 Worley gathered the data below for two of the many hospitals that it serves—University and Memorial (each hospital purchased medical supplies that had cost Worley $30,000 to buy from manufacturers): Activity Activity Measure University Memorial Number of deliveries 10 25 Number of manual orders 0 30 Number of electronic orders 15 0 Number of line items picked 120 250 Required: 1. Compute the total revenue that Worley would receive from University and Memorial. 2. Compute the activity rate for each activity cost pool. 3. Compute the total activity costs that would be assigned to University and Memorial.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 5%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $105 to purchase these supplies.
For years, Worley believed that the 5% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits, Worley decided to implement an 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:
| Activity Cost Pool (Activity Measure) | 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 items picked) | 450,000 | 450,000 | line items | |
| Other organization-sustaining costs (None) | 602,000 | |||
| Total selling and administrative expenses | $ | 2,000,000 | ||
Worley gathered the data below for two of the many hospitals that it serves—University and Memorial (each hospital purchased medical supplies that had cost Worley $30,000 to buy from manufacturers):
|
Activity |
||
| Activity Measure | University | Memorial |
| Number of deliveries | 10 | 25 |
| Number of manual orders | 0 | 30 |
| Number of electronic orders | 15 | 0 |
| Number of line items picked | 120 | 250 |
Required:
1. Compute the total revenue that Worley would receive from University and Memorial.
2. Compute the activity rate for each activity cost pool.
3. Compute the total activity costs that would be assigned to University and Memorial.
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