Chapter 18, Problem 18.18EX

Construct and interpret a product profitability report, allocating selling and administrative expenses

Naper Inc. manufactures power equipment. Naper has two primary products—generators and air compressors. The following report was prepared by the controller for Naper’s senior marketing management for the year ended December 31:

	Generators	Air Compressors	Total
Revenue	$4,200,000	$3,000,000	$7,200,000
Cost of goods sold	2,940,000	2,100,000	5,040,000
Gross profit	$1,260,000	$ 900,000	$2,160,000
Selling and administrative expenses			610,000
Income from operations			$1,550,000

The marketing management team was concerned that the selling and administrative expenses were not traced to the products. Marketing management believed that some products consumed larger amounts of selling and administrative expense than did other products. To verify this, the controller was asked to prepare a complete product profitability report, using activity-based costing.

The controller determined that selling and administrative expenses consisted of two activities: sales order processing and post-sale customer service. The controller was able to determine the activity base and activity rate for each activity, as follows:

Activity	Activity Base	Activity Rate
Sales order processing	Sales orders	$ 65 per sales order
Post-sale customer service	Service requests	$200 per customer service request

The controller determined the following activity-base usage information about each product:

	Generators	Air Compressors
Number of sales orders	3,000	4,000
Number of service requests	225	550

A. Determine the activity cost of each product for sales order processing and post-sale customer service activities.

B. Use the information in (A) to prepare a complete product profitability report dated for the year ended December 31. Compute the gross profit to sales and the income from operations to sales percentages for each product. (Round to two decimal places.)

C. Interpret the product profitability report. How should management respond to the report?