Revenue and Customer-level Operating Costs Essay

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Pages: 6
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5-41 (30-40 mins.) Activity-based costing, cost hierarchy.

1.

Super Bookstore

Income Statement

For the Year Ended 31 December, 2010

Books CDs Café Total
Revenues
$3,720,480 $2,315,360 $736,216 $6,772,056
Cost of Merchandise 2,656,727
1,722,311
556,685 4,935,723
Cost of Café Cleaning

18,250 18,250
Allocated Selling, General and Administration Costsa (0.300986 × $2,656,727; $1,722,311; $556,685) 799,638 518,392 167,554 1,485,584
Operating income $ 264,115 $ 74,657
$ (6,273) $ 332,499

aOverhead rate = $1,485,584 ÷ $4,935,723 = 0.300986 per cost of merchandise dollar

2. Selling, general and administration (S,G & A) is comprised of a variety of costs that are unlikely to be consumed uniformly across product lines based on the cost of merchandise. Super Bookstore should consider an activity-based costing system to clarify how each product line uses these S, G & A resources.

Books
CDs
Café
Total
Number of purchase orders 2,800 2,500 2,000 7,300
Number of deliveries received 1,400 1,700 1,600 4,700
Hours of shelf-stocking time 15,000 14,000 10,000 39,000
Items sold
124,016
115,768
368,108
607,892

Purchasing
$474,500 ÷ 7,300 orders placed = $65 per purchase order
Receiving
$432,400 ÷ 4,700 deliveries = $92 per delivery
Stocking
$487,500 ÷ 39,000 hours = $12.50 per stocking hour
Customer support
$91, 184 ÷ 607,892 items sold = $0.15 per item sold

Books CDs Café Total
Revenues
$3,720,480 $2,315,360
$ 736,216 $6,772,056
Cost of Merchandise 2,656,727 1,722,311 556,685 4,935,723
Gross margin 1,063,753 593,049 179,531 1,836,333
Cost of Café Cleaning

18,250
18,250
Purchasing
($65 × 2,800; 2,500; 2,000)
182,000
162,500
130,000
474,500
Receiving
($92 × 1,400; 1,700; 1,600)
128,800
156,400
147,200
432,400
Shelf-stocking
($12.50 × 15,000; 14,000; 10,000)
187,500
175,000
125,000
487,500
Customer support
($0.15 × 124,016; 115,768; 368,108 18,603 17,365 55,216 91,184
Total S, G & A costs 516,903 511,265 475,666 1,503,834
Operating income
$ 546,850 $ 81,784
$(296,135)
$ 332,499

Comparing product line income statements in requirements 1 and 2, it appears that books are much more profitable and café loses a lot more money under the ABC system compared to the simple system. The reason is that books use far fewer S,G & A resources relative to its merchandise costs and café uses far greater S, G & A resources relative to its merchandise costs.

3.
To: Super Bookstore Management Team
From: Cost Analyst
Re: Costing System

The current accounting system allocates indirect costs (S,G & A) to product lines based on the Cost of Merchandise sold. Using this method, the S, G & A costs are assigned 54%, 35%, 11%, to the Books, CDs, and Café product lines, respectively.

I recommend that the organization switch to an activity-based costing (ABC) method. With ABC, the product lines are assigned indirect costs based on their consumption of the activities that give rise to the costs. An ABC analysis reveals that the Café consumes considerably more than 11% of indirect costs. Instead, the café generally requires 25-35% of the purchasing, receiving and stocking activity and 60% of the customer support.

The current accounting technique masks the losses being produced by the café because it assumes all indirect costs are driven by the dollar amount of merchandise sold. By adopting ABC, management can evaluate the costs of operating the three product lines and make more informed pricing and product mix decisions. For example, management may want to consider increasing prices of the food and drinks served in the café. Before deciding whether to increase prices or to close the café, management must consider the beneficial effect that having a cafe has on the other product lines.

An ABC analysis can also help Super Bookstore manage its
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