Activity Based costing

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Activity Based costing :

Activity Based costing

Case study (cont… :

Case study (cont… Particulars Soft drinks Fresh Produce Packaged Food Revenues 317,400 840,240 483,960 Cost of goods sold 240,000 600,000 360,000 Cost of bottles returned 4,800 0 0 Number of purchase orders placed 144 336 144 Number of deliveries received 120 876 264 Hours of shelf-stocking time 216 2,160 1,080 Items sold 50,400 441,600 122,400

FS also provides the following information for 2013:

FS also provides the following information for 2013 Activity (1) Description of Activity (2) Total cost (3) cost-Allocation Base (4) 1. Bottles returns Returning of empty bottles to store 4,800 Direct tracing to soft-drink line 2. Ordering Placing of orders for purchases 62,400 624 purchase orders 3. Delivery Physical delivery and receipt of merchandise 100,800 1,260 deliveries 4. Shelf – stocking Stocking of merchandise on store shelves and ongoing restocking 69,120 3,456 hours of shelf – stocking time 5. Customer support Assistance provided to customers, including checkout and bagging 122,880 614,400 items sold Total store support cost 360,000

Required:

Required Family Supermarkets currently allocates store support costs (all costs other than cost of goods sold) to product lines on the basis of cost of goods sold of each product line. Calculate the operating income and operating income as a percentage of revenues for each product line. If family Supermarkets allocates store support costs (all costs other than cost of goods sold ) to product line using an ABC system, calculate the operating income and operating income as a percentage of revenues for each product line. Comment on your answers in requirements 1 & 2.

Solutions: A.) :

Solutions: A.) Particulars Soft Drinks Fresh Produce Packaged Food Total Revenue 317,400 840,240 483,960 1,641,600 Cost of goods sold 240,000 600,000 360,000 1,200,000 Store support cost (240,000;600,000;360,000)*0.30 72,000 180,000 108,000 360,000 Total cost 312,000 780,000 468,000 1,560,000 Operating income 5,400 60,240 15,960 81,600 Operating income/Revenues 1.70% 7.17% 3.30% 4.97%

Explanation::

Explanation: The table shows the operating income and operating income as a percentage of revenues for each product line. All store support costs (all costs other than cost of goods sold) are allocated to product lines using cost of goods sold of each product line as the cost allocation base. Total store support costs equal 360,000(cost of bottles returned, 4800 + cost of purchase orders, 62400 + cost of deliveries, 100800 + cost of shelf stocking, 69120 + cost of customer support, 122880). The allocation rate for store support cost = 360,000/1,200,000 =30% of cost of goods sold . To allocate support costs to each product line, FS multiplies the cost of goods sold of each product line by 0.30.

B.):

B.) Under ABC system, FS identifies bottle-return costs as a direct cost because these costs can be traced to the soft drink product line. FS then calculates cost allocation rates for each activity area (as in step 5). The activity rates are as follows: Activity (1) Cost hierarchy (2) Total cost (3) Quantity of cost allocation Base (4) Overhead allocation Rate (5) = (3)/(4) Ordering Batch level 62,400 624 purchase orders 100 per purchase order Delivery Batch level 100,800 1,260 deliveries 80 per deliveries Shelf stocking Output-input level 69,120 3,456 shelf stocking hours 20 per stocking hour Customer support Output-input level 122,880 614,400 items sold 0.20 per item sold

PowerPoint Presentation:

Store support costs for each product line by activity are obtained by multiplying the total quantity of the cost allocation base for each product line by the activity cost rate. Operating income and operating income as a percentage of revenues for each product line are as follows:

PowerPoint Presentation:

Particulars Soft Drinks Fresh Produce Packaged Food Total Revenues 317,400 840,240 483,960 1,641,600 Cost of goods sold 240,000 600,000 360,000 1,200,000 Bottle return costs 4,800 0 0 4,800 Ordering costs (144;336;144) purchase orders*100 14,400 33,600 14,400 62,400 Delivery costs (120;876;264) deliveries*80 9,600 70,080 21,120 100,800 Shelf stocking costs (216:2,160;1080) stocking hours * 20 4,320 43,200 21,600 69,120 Customer support cost (50,400;441,600;122,400) items sold*0.20 10,080 88,320 24,480 122,880 Total cost 283,200 835,200 441,600 1,560,000 Operating income 34,200 5,040 42,360 81,600 Operating income/Revenues 10.78% 0.60% 8.75% 4.97%

C.):

C.) Managers believe the ABC system is more credible than its previous costing system. The ABC system distinguishes the different types of activities at FS more precisely. It also tracks more accurately how individual product line use resources. Rankings of relative profitability – that’s the percentage of operating income to revenues – of the three product lines under the previous costing system and under the ABC system are: Previous Costing Systems ABC System 1. Fresh Produce 7.17% Soft drinks 10.78% 2. Packaged Food 3.30% Packaged Food 8.75% 3. Soft drinks 1.70% Fresh Produce 0.60%

The percentage of revenues, cost of goods sold, and activity costs for each product line are as follows::

The percentage of revenues, cost of goods sold, and activity costs for each product line are as follows: Particulars Soft Drinks Fresh Produce Packaged Food Revenues 19.34% 51.18% 29.48% Cost of goods sold 20.00 50.00 30.00 Bottle returns 100.00 0 0 Activity areas: Ordering 23.08 53.84 23.08 Delivery 9.53 69.52 20.95 Shelf – stocking 6.25 62.50 31.25 Customer support 8.20 71.88 19.92

Explanation:

Explanation Soft drinks consume less resources than either fresh produce or packaged food. Soft drinks have fewer deliveries and require less shelf – stocking time than required for either fresh produe or packaged food. Most majorsoft – drink suppliers deliver merchandise to the store shelves and stock the shelves themselves. In contrast, the fresh produce area has the most deliveries and consumes a large percentage of shelf stocking time. It also has the highest number of individual sales items. The previous costing system assumed that each product line used the resources in each activity area in the same ratio as their respective individual cost of goods sold to total cost of goods sold. Clearly, this assumption is incorrect. The previous costing system is an example of broad averaging via cost smoothing.

PowerPoint Presentation:

FS managers can use the ABC information to guide their decisions, such as how to allocate a plan increase in floor space. An increase in the percentage of space allocated to soft drinks is warranted. Note, however, that ABC information should be but one input into decisions about shelf- space allocation. FS may have minimum limit on the shelf space allocated to fresh produce because of shoppers’ expectations that supermarkets will carry products from this product line. In many situations, companies cannot make product decisions in isolation but must consider the effect that dropping a product might have on customer demand for other products. Pricing decisions can also be made in a more informed way with ABC information. For example, suppose a competitor announces a 5% reduction in soft drink prices. Given the 10.77% margin FS currently earns on its soft drink product line, it has flexibility to reduce prices and still make a profit on this product line. In contrast, the previous costing system erroneously implied that soft drinks only had a 1.70% margin, leaving little room to counter a competitor’s pricing initiatives.

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