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Concept explainers
Activity-based costing for a service company
Wells Fargo insurance Services (WFIS) is an insurance brokerage company that classified insurance products as either “easy” or “difficult.” Easy and difficult products were defined as follows:
Easy: Electronic claims, few inquiries, mature product
Difficult: Paper claims, complex claims to process, many inquiries, a new product with complex options
The company originally allocated processing and service expenses on the basis of revenue. Under this traditional allocation approach, the product profitability report revealed the following:
Easy Product | Difficult Product | Total | |
Revenue | $600 | $400 | $1,000 |
Processing and service expenses | 420 | 280 | 700 |
Income from operations | $180 | $120 | $ 300 |
Operating income margin | 30% | 30% | 30% |
WFIS decided to use activity-based costing to allocate the processing and service expenses. The following activity-based costing analysis of the same data illustrates a much different profit picture for the two types of products:
Easy Product | Difficult Product | Total | |
Revenue | $600 | $400 | $1,000 |
Processing and service expenses | 183 | 517 | 700 |
Income from operations | $417 | $(117) | $ 300 |
Operating income margin | 70% | (29%) | 30% |
Explain why the activity-based profitability report reveals different information from the traditional sales allocation report.
Source: Dan Patras and Kevin Clancy, “ABC in the Service Industry: Product Line Profitability at Acordia, Inc.” As Easy as ABC Newsletter, issue 12. Spring 1993
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Chapter 26 Solutions
Financial & Managerial Accounting
- Which of the following is not a reason for banks to use activity- based costing? C a. to determine profitability of services provided Ob. to determine service quality c. to determine the amounts charged to customers for services provided Od. all of the abovearrow_forwardAlter's Home Center (AHC) sells renovation and remodeling products to both contractors and individual home owners. One of the services AHC offers is delivery of the purchased products to the customer's work site. Because not all customers take advantage of the delivery service option, ACH adds 10 percent to the cost of the products purchased to cover the delivery cost. A business intern spent the summer at ACH. The intern's assignment was to analyze the delivery service and recommend a better way to charge customers for using it. The intern, who had studied activity-based costing, identified the following activities and the data related to them: Activity Picking order Delivering order Handling complaints Total delivery cost Total order value (before delivery charge) Number of orders Cost Driver Number of items Number of orders Number of complaints The intern selected two customers, who were frequent customers, to use as an illustration of the system: Wagner Remodeling and Burlington…arrow_forwardEmployee training is an example of discretionary fixed costs. Select one: True False Below are the measures of cost functions except: a. Regression analysis b. Engineering analysis c. Visual fit analysis d. Maintenance analysis Cost behavior is linear in nature on cost driver levels. Select one: True False Discretionary cost are the fixed cost that are able to achieve at desired level of service or production. Select one: True False Period costs are the cost identified with goods produced. Select one: True False Lease payment is the example of discretionary fixed cost. Select one: True False Below are the examples of committed costs, except: a. Mortgage payment b. Depreciation c. Tax payment d. Management salary Direct labor cost includes wages of all the labors that can be traced specifically. Select one: True False Cost are assumed to be fixed or changes within the relevant range of activity. Select one: True Falsearrow_forward
- You have been asked by management to classify the costs associated with the start-up of this new product line. Using the cost information provided below, classify each cost under the appropriate heading according to the chart provided below. Note that some costs may be classified under more than one heading. For example, a cost may be a fixed cost and a period cost. Name of cost Variable Cost Fixed Cost Direct Materials Direct Labor Factory Overhead Period Cost Prime Cost Conversion Cost Carlson “New Product” Cost Information Cost Amount Cost Type Depreciation on Building (annual) $ 10,000 Direct Labor Cost (per unit) $ 75 Direct Materials Cost (per unit) $ 60 Factory Utilities (per unit) $ 8 Indirect Materials (per unit) $ 4 Interest on Investments (annual) $3,000 Machinery Rental (monthly) $ 6,000 Marketing (annual) $ 35,000 Rent from Tenant (annual) $40,000…arrow_forwardWhich of the following statements is not a characteristic of a target costing system? It is a good system to compare the cost of your products with that of your competitors Assists with ensuring that a business can achieve its desired profit levels Focuses on cost reductions after the product has been designed Focuses on the manufacturing processes to see if improvements can be made from a cost perspective.arrow_forward1. Customer profitability analysis allows managers to do which of the following:a. Identify the closest competitor.b. Focus solely on service calls.c. Sell to higher end customers.d. Manage each customers costs-to-serve. 2. Transferred-in units and cost flows are similar to:a. Materials added at the end of the process.b. Materials added at the beginning of the process.c. Conversion costs added at the end of the process.d. Conversion costs added at the beginning of the process.3. In making decisions about whether to sell at split-off or process joint products further, the allocation of joint manufacturing costs is treated as a(n):a. Essential costb. Weighted average costc. Sunk costd. Period cost 4. Cost allocation provides a service firm a basis for evaluating the:a. Cost and profitability of its services.b. Value of its services.c. Manufacturing costs for the company.d. The exact cost of each department 5. Customer lifetime value is concerned with which of the following:a.…arrow_forward
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