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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