Question

Herlocker Supermarkets (HS) is a regional supermarket chain operating in the Pacific Northwest. HS’s management has recently become concerned because its Eugene, Oregon store is barely breaking even.

HS has decided to develop Activity-Based Cost (ABC) information about the profitability of the three product lines carried in the Eugene store: soft drinks, fresh produce, and packaged foods in order to assess the long-run viability of different products and how they contribute to overall profit.

HS has collected the following 2019 data about Gross Margin (Revenue less Cost of goods sold) and various support activities for each product line:

	Soft Drinks	Fresh Produce	Packaged Food	Total
Revenues	$      357,000	$   1,062,500	$      533,750	$   1,953,250
Cost of goods sold	$      295,000	$      807,500	$      423,500	$   1,526,000
Number of bottles returned	65,000	-	-	65,000
Number of purchase orders placed	144	372	164	680
Number of deliveries received	130	1,020	360	1,510
Hours of shelf-stocking time	224	2,460	1,256	3,940
Items sold	52,100	495,500	132,400	680,000

HS has also produced the following information about the support costs of running the store for 2019, arranged into various activity cost pools, and the best available cost driver (or allocation base):

Activity	Description of Activity	Support Costs	Allocation Base
Bottle returns	Returning of empty bottles to store	$             6,500	Direct tracing to soft drink line
Shelf-stocking	Stocking of merchandise on store shelves and ongoing restocking	$           75,120	Hours of shelf-stocking time
Delivery	Physical delivery and receipt of merchandise	$          120,200	Number of deliveries received
Customer support	Assistance provided to customers, including checkout and bagging	$          148,900	Number of items sold
Ordering	Placing of orders for purchases	$           68,400	Number of purchase orders placed
	Total Support Costs	$          419,120

1. HS has always allocated store support costs (that is, the $419,120 of costs in the table above) to product lines on the basis of the proportion of cost of goods sold for each product line. Using this approach to allocating support cost, calculate operating income (or loss) both in dollars of profit (or loss) and as a percentage of revenue for each product line.
2. What strategy does this traditional system of accounting for store support costs suggest to increase the profitability of the Eugene store?
3. Now suppose HS allocates the $419,120 of store support costs to product lines using an ABC system based on the activity cost and cost driver information provided above. Calculate the ABC operating income (or loss) both in total and as a percentage of revenue for each product line.
4. What strategy does this ABC system suggest to increase the profitability of the Eugene store?
5. What is driving the differences in profitability between the profitability you calculated using the traditional system to the profitability you calculated using the ABC system?

Answer 1

A 1 Solution : 2 1. Calculation of amount of Total support Costs assinged to each product line uses Traditional Costing System 3 Total Overhead Costs $419,120 Soft Drinks Fresh Produce Packaged Food 5 Particulars 6 Cost of Goods Sold (Cost Driver) $295,000 $807,500 $423,500 8 Total Support Costs Assigned $81,022.54 $221,782.04 $116,315.41 (419120 *423500)/1526000 (419120 *295000)/1526000 (419120 *807500)/1526000 13 2. Calculation of production cost for each product using Traditional costing system :- Soft Drinks 15 Particulars 16 Cost of Goods Sold (A) 17 Total Support Costs (B) 18 Total Production Costs (A+B) $295,000.00 $81,022.54 $376,022.54 Fresh Produce $807,500.00 $221,782.04 $1,029,282.04 Packaged Food $423,500.00 $116,315.41 $539,815.41

22 3. Calculation of Operating Income for each product using Traditional costing system :- Soft Drinks Fresh Produce 24 Particulars 25 Revenues (A) 26 Less Production Costs (B) $357,000.00 $376,022.54 $1,062,500.00 $1,029,282.04 Packaged Food $533,750.00 $539,815.41 28 Operating Profit (Loss) (A-B) I ($19,022.54) $33,217.96 ($6,065.41) 33 4. Calculation of Activity rates for each activity cost pool :- 35 Activity Rate = Total Overhead ( Related to cost driver ) / Cost Driver Annual Costs (A) 37 Activity Cost pool 88 Bottle Returns Driver (B) $6,500 65000 Bottles Returned Activity Rate (A/B) 6500 / 65000 = $ 0.10 per bottle 30 Shelf Stocking $75,120 3940 Hrs of Shelf Stocking Time 75120 / 3940 = $ 19.07 per hr 22 Delivery $120,200 1510 Deliveries Received 120200 / 1510 = $ 79.60 per delivery 14 Customer Support $148,900 680000 Units 148900 / 680000 = $ 0.22 per unit 26 Ordering $68,400 680 Purchase orders 68400/ 680 = $ 100.59 per order

49 50 5. Calculation of Total Support costs that would be assigned to each product based on activity based costing 51 Activity Cost Pool Soft Drinks Fresh Produce 52 Bottle Returns (A) $6,500 65000 Bottles * $ 0.10 per bottle) Packaged Food 53 55 Shelf Stocking (B) $4,272 _ |(2460 Hrs * $ 19.07 per Hr ) $23,952 $46,912 |(1256 Hrs * $ 19.07 per Hr ) 56 (224 Hrs * $ 19.07 per Hr ) 58 Delivery (C) $10,348 $81,192 (130 Deliveries * $ 79.60 per Delivery) |(1020 Deliveries * $ 79.60 per Delivery) $28,656 (360 Deliveries * $ 79.60 per Delivery) 60 61 Customer Support (D) $11,462 $ 109,010 $29,128 (52100 Units * $ 0.22 per Unit) (495500 Units * $ 0.22 per Unit) (132400 Units * $ 0.22 per Unit) 64 Ordering (E) $37,419 $14,485 (144 Orders * $ 100.59 per Order) $16,497 (164 Orders * $ 100.59 per Order) (372 Orders * $ 100.59 per Order) 67 Total Support Costs (A+B+C+D+E) $ 47,067 $274,534 $98,233 70 6. Calculation of production cost per unit for each product using Activity Based costing system :- Soft Drinks Fresh Produce Packaged Food 72 Particulars 73 Cost of Goods Sold (A) 74 Total Support Costs (B) 75 Total Production Costs ( A+B) 76 $295,000.00 $47,066.64 $342,066.64 $807,500.00 $274,533.68 $1,082,033.68 $423,500.00 $98,232.68 $521,732.68

- 9 7. Calculation of Operating Profit for each product using ABC system: Soft Drinks Fresh Produce Packaged Food 1 Particulars 2 Revenues (A) 3 Less :Production Costs (B) $357,000.00 $342,066.64 $1,062,500.00 $1,082,033.68 $533,750.00 $521,732.68 5 Operating Profit (Loss) (A-B) $14,933.36 ($19,533.68) $12,017.32 9 8. Comparison of Operating Profit (Loss) under Traditional costing & ABC system :- Soft Drinks Fresh Produce Packaged Food 1 Particulars 2 Operating Profit (Loss) (Traditional) 3 Operating Profit (Loss) (ABC) ($19,022.54) $14,933.36 $33,217.96 ($19,533.68) ($6,065.41) $12,017.32 5 There is Operating Profit for Fresh Produce in case of Traditional Costing System whereas 6 there is Operating Profit for Soft Drinks & Packaged Food in ABC System. Therefore, If Company 7 uses Traditional costing method, then it should produce Fresh Produce products, where as 3 in case of ABC System, it should produce more Soft Drinks & Packaged Food products.