Chapter 4, Problem 5PB

1.

To determine

Activity-based costing (ABC) method: The costing method which allocates overheads to the products based on factory overhead rate for each activity or cost object, according to the cost pooled for the cost drivers (allocation base).

Formula to compute activity-based overhead rate:

$\begin{array}{l}\text{Activity-based}\\ \text{overhead rate}\end{array}\}\text{ = }\frac{\text{Budgeted activity cost}}{\text{Total activity-base usage}}$

To compute: The activity-based overhead rate for each of the given activities

Explanation of Solution

Compute activity-based overhead rates.

Computation of Activity-Based Overhead Rates
Activity Cost Pools	Activity Cost	÷	Total Activity-Base Usage	=	Activity-Based Overhead Rates
Customer support	$76,860	÷	427 requests	=	$180 per request
Sales order processing	25,920	÷	1,080 orders	=	$24 per order
Advertising support	311,250	÷	249 advertisements	=	$1,250 per ad

Table (1)

2.

To determine

To compute: The activity-cost allocated to each of the products

Explanation of Solution

Compute activity cost allocated to Company W.

Activity Cost Pools	Activity-Based Overhead Rates	×	Actual Use of Activity-Base	=	Activity Cost Allocated
Customer support	$180 per request	×	62 requests	=	$11,160
Sales order processing	$24 per order	×	300 orders	=	7,200
Advertising support	$1,250 per ad	×	25 ads	=	31,250
Total activity costs allocated to Company W					$49,610

Table (2)

Note: Refer to Table (1) for value and computation of activity-based overhead rate.

Compute activity cost allocated to Company K.

Activity Cost Pools	Activity-Based Overhead Rates	×	Actual Use of Activity-Base	=	Activity Cost Allocated
Customer support	$180 per request	×	340 requests	=	$61,200
Sales order processing	$24 per order	×	640 orders	=	15,360
Advertising support	$1,250 per ad	×	180 ads	=	225,000
Total activity costs allocated to Company K					$301,560

Table (3)

Note: Refer to Table (1) for value and computation of activity-based overhead rate.

Compute activity cost allocated to Company SU.

Activity Cost Pools	Activity-Based Overhead Rates	×	Actual Use of Activity-Base	=	Activity Cost Allocated
Customer support	$180 per request	×	25 requests	=	$4,500
Sales order processing	$24 per order	×	140 orders	=	3,360
Advertising support	$1,250 per ad	×	44 ads	=	55,000
Total activity costs allocated to Company SU					$62,860

Table (4)

Note: Refer to Table (1) for value and computation of activity-based overhead rate.

3.

To determine

To draft: Customer profitability report of Incorporation S for the year ended December 31

Explanation of Solution

Prepare customer profitability report of Incorporation S for the year ended December 31.

Incorporation S
Customer Profitability Report
For the Year Ended December 31
	Company W	Company K	Company SU
Revenues	$899,100	$899,100	$899,100
Cost of goods sold	552,420	552,420	552,420
Gross profit	346,680	346,680	346,680
Selling and administrative expenses:
Customer support	$11,160	$61,200	$4,500
Project bidding	7,200	15,360	3,360
Engineering support	31,250	225,000	55,000
Total selling expenses	$49,610	$301,560	$62,860
Income (loss) from operations	$297,070	$45,120	$283,820

Table (5)

Working Notes:

Refer to Tables (2), (3) and (4) for value and computation of selling and administrative expenses for the three customers.

Compute sales revenues for each of the customers.

Customers	Number of Units Sold	×	Selling Price Per Unit	=	Sales Revenue
Company W	810 units	×	$1,110	=	$899,100
Company K	810 units	×	1,110	=	899,100
Company SU	810 units	×	1,110	=	899,100

Table (6)

Compute cost of goods sold for each product.

Customers	Number of Units Sold	×	Cost Price Per Unit	=	Cost of Goods Sold
Company W	810 units	×	$682	=	$552,420
Company K	810 units	×	682	=	552.420
Company SU	810 units	×	682	=	552.420

Table (7)

4.

To determine

To discuss: The inferences from the customer profitability report.

Explanation of Solution

Company W and Company SU are profitable customers whereas Company K has low margin. This is due to the high activity costs for all the three activities. Company K is suggested to increase its sales volume to overcome its costs. Due to high costs and low revenues, the customer experienced losses.