Reference no: EM132758782

Question - Pyrohy Industries Ltd. has experienced growth recently, with its sales staff successfully adding new customers to its existing customer base. Although revenues have increased significantly, operating profits have not. The manager of the sales department is extremely happy with the additional commissions that he and his staff have earned, but the division manager is not pleased at all. After a heated discussion during a management meeting, the cost accountant was asked to provide information on two recently-added customers. Given the concerns of the division manager, the accountant recommended the use of activity-based accounting for this analysis and the data gathered is presented below:

Alma Industries Ltd. Barbara Supplies Inc.

Sales revenue, last quarter $180,000 $220,000

Contribution margin percentage 40% 25%

Number of sales visits during quarter 2 6

Number of regular orders placed 2 12

Number of rush orders placed 0 2

Number of unique items per regular order 100 15

Number of unique items per rush order 0 3

The cost accountant noted that the lower contribution margin on sales to Barbara is because receives a discount on its purchases because they exceed $200,000 per quarter. There are two separate activities involved in processing a sales order. Time spent to accept the order and verify the customer status is the same for each order, regardless of the size of the order or whether it is a rush or regular order. Time spent on data entry for the order differs significantly though, based on the number of unique items in the order. Rush orders disrupt normal data processing, stock retrieval and deliveries, resulting in costs that do not occur for regular orders. All of these extra costs have been combined in the estimated costs for rush deliveries presented below. Additionally, each order, whether regular or rush, is sent to the customer as a single delivery.

Activity Total cost of activity Allocation base Expected total volume

Sales visits $300,000

Number of sales visits 300

Order acceptance $64,000

Number of orders Regular 160

Rush 25

Data entry $28,600

Number of unique items 13,000

Rush order processing $18,750

Number of rush orders 25

Deliveries $66,600

Number of deliveries 185

Total $477,950

Required -

a) Calculate the cost per unit of the allocation base for each activity.

b) Determine the profitability of each of these two customers, using activity-based costing.

c) Describe two ways in which the less profitable of these two customers could be made more profitable. Be specific as to what management should do to achieve this result.

d) An alternate way of allocating the customer service costs would be to use a single rate based on the number of customers. If Pyrohy has 80 customers, calculate the overhead rate, assuming the total overhead cost is the same as the total activity costs. Determine the cost assigned to each of the two customers.

e) Evaluate whether the use of activity-based costing or a single rate provides more accurate information for assessing the profitability of a specific customer.