Problem for Self-Study

Family Supermarkets (FS) has decided to increase the size of its Memphis store. It wants information about the profitability of individual product lines: soft drinks, fresh produce, and packaged food. FS provides the following data for 2020 for each product line:

<p>A table gives 2020 data for each product line from Family Supermarkets</p>

The table depicts revenues, cost of goods sold, cost of bottles returned, number of purchase orders placed, number of deliveries received, hours of shelf-stocking time, and items sold for soft drinks, fresh produce, and packaged food. The details of the table are as follows:

  1. Revenues
    • Soft drinks: 317,400 dollars
    • Fresh produce: 840,240 dollars
    • Packaged food: 483,960 dollars
  1. Cost of goods sold
    • Soft drinks: 240,000 dollars
    • Fresh produce: 600,000 dollars
    • Packaged food: 360,000 dollars
  1. Cost of bottles returned
    • Soft drinks: 4,800 dollars
    • Fresh produce: 0 dollars
    • Packaged food: 0 dollars
  1. Number of purchase orders placed
    • Soft drinks: 144
    • Fresh produce: 336
    • Packaged food: 144
  1. Number of deliveries received
    • Soft drinks: 120
    • Fresh produce: 876
    • Packaged food: 264
  1. Hours of shelf-stocking time
    • Soft drinks: 216
    • Fresh produce: 2,160
    • Packaged food: 1,080
  1. Items sold
    • Soft drinks: 50,400
    • Fresh produce: 441,600
    • Packaged food: 122,400

FS also provides the following information for 2020:

<p>A table gives 2020 data for Family Supermarkets</p>

The table depicts five activities (bottle returns, ordering, delivery, shelf stocking, and customer support) with their descriptions, total support costs, and cost-allocation base, along with an overall total of support costs. The details of the table are as follows:

  1. Bottle returns
    • Description of activity: Returning of empty bottles to store
    • Total support costs: 4,800 dollars
    • Cost-allocation base: Direct tracing to soft-drink line
  1. Ordering
    • Description of activity: Placing of orders for purchases
    • Total support costs: 62,400 dollars
    • Cost-allocation base: 624 purchase orders
  1. Delivery
    • Description of activity: Physical delivery and receipt of merchandise
    • Total support costs: 100,800 dollars
    • Cost-allocation base: 1,260 deliveries
  1. Shelf stocking
    • Description of activity: Stocking of merchandise on store shelves and ongoing restocking
    • Total support costs: 69,120 dollars
    • Cost-allocation base: 3,456 hours of shelf-stocking time
  1. Customer support
    • Description of activity: Assistance provided to customers, including checkout and bagging
    • Total support costs: 122,880 dollars
    • Cost-allocation base: 614,400 items sold
  1. Total support costs for all activities: 360,000 dollars

Required

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

Solution

  1. 1. The following 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, $4,800+cost of purchase orders, $62,400+cost of deliveries, $100,800+cost of shelf stocking, $69,120+cost of customer support, $122,880). The allocation rate for store support costs=$360,000÷$1,200,000 (soft drinks $240,000 + fresh produce $600,000 + packaged food, $360,000) = 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.

<p>A table gives 2020 data for Family Supermarkets, allocating support costs to each product line</p>

The table depicts revenues, cost of goods sold, cost of bottles returned, number of purchase orders placed, number of deliveries received, hours of shelf-stocking time, and items sold for soft drinks, fresh produce, and packaged food. The details of the table are as follows:

  1. Revenues
    • Soft drinks: 317,400 dollars
    • Fresh produce: 840,240 dollars
    • Packaged food: 483,960 dollars
    • Total: 1,641,600 dollars
  1. Cost of goods sold
    • Soft drinks: 240,000 dollars
    • Fresh produce: 600,000 dollars
    • Packaged food: 360,000 dollars
    • Total: 1,200,000 dollars
  1. Store support cost
    • Soft drinks, 240,000 dollars times 0.30: 72,000 dollars
    • Fresh produce, 600,000 dollars times 0.30: 180,000 dollars
    • Packaged food, 360,000 dollars times 0.30: 108,000 dollars
    • Total, 1,200,000 dollars times 0.30: 360,000 dollars
  1. Total costs
    • Soft drinks: 312,000 dollars
    • Fresh produce: 780,000 dollars
    • Packaged food: 468,000 dollars
    • Total: 1,560,000 dollars
  1. Operating income
    • Soft drinks: 5,400 dollars
    • Fresh produce: 60,240 dollars
    • Packaged food: 15,960 dollars
    • Total: 81,600 dollars
  1. Operating income divided by revenues
    • Soft drinks: 1.70 percent
    • Fresh produce: 7.17 percent
    • Packaged food: 3.30 percent
    • Total: 4.97 percent
  1. 2. The ABC system 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 of the seven-step costing system, described earlier on page 163). The activity rates are as follows:

<p>A table gives 2020 activity rates data for Family Supermarkets</p>

The table depicts ordering, delivery, shelf stocking, and customer support with their cost hierarchy, total costs, quantity of cost-allocation base, and overhead allocation rate. The details of the table are as follows:

  1. Ordering
    • Cost hierarchy: Batch-level
    • Total costs: 62,400 dollars
    • Quantity of cost-allocation base: 624 purchase orders
    • Overhead allocation rate (total costs divided by quantity of cost-allocation base): 100 dollars per purchase order
  1. Delivery
    • Cost hierarchy: Batch-level
    • Total costs: 100,800 dollars
    • Quantity of cost-allocation base: 1,260 deliveries
    • Overhead allocation rate (total costs divided by quantity of cost-allocation base): 80 dollars per delivery
  1. Shelf stocking
    • Cost hierarchy: Output unit-level
    • Total costs: 69,120 dollars
    • Quantity of cost-allocation base: 3,456 shelf-stocking hours
    • Overhead allocation rate (total costs divided by quantity of cost-allocation base): 20 dollars per stocking-hour
  1. Customer support
    • Cost hierarchy: Output unit-level
    • Total costs: 122,880 dollars
    • Quantity of cost-allocation base: 614,400 items sold
    • Overhead allocation rate (total costs divided by quantity of cost-allocation base): 0.20 dollars per item sold

 

  1. 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:

<p>A table gives operating income and operating income as a percentage of revenues for each product line</p>

The table depicts revenues, cost of goods sold, bottle-return costs, ordering costs, delivery costs, shelf-stocking costs, customer-support costs, total costs, operating income, and operating income divided by revenues for soft drinks, fresh produce, and packaged food, as well as totals. The details of the table are as follows:

1. Revenues

      • Soft drinks: 317,400 dollars
      • Fresh produce: 840,240 dollars
      • Packaged food: 483,960 dollars
      • Total: 1,641,600 dollars

2. Cost of goods sold

      • Soft drinks: 240,000 dollars
      • Fresh produce: 600,000 dollars
      • Packaged food: 360,000 dollars
      • Total: 1,200,000 dollars

3. Bottle-return costs

      • Soft drinks: 4,800 dollars
      • Fresh produce: 0 dollars
      • Packaged food: 0 dollars
      • Total: 4,800 dollars

4. Ordering costs

      • Soft drinks, 144 purchase orders times 100 dollars: 14,400 dollars
      • Fresh produce, 336 purchase orders times 100 dollars: 33,600 dollars
      • Packaged food, 144 purchase orders times 100 dollars: 14,400 dollars
      • Total: 162,400 dollars

5. Delivery costs

      • Soft drinks, 120 deliveries times 80 dollars: 9,600 dollars
      • Fresh produce, 876 deliveries times 80 dollars: 70,080 dollars
      • Packaged food, 264 deliveries times 80 dollars: 21,120 dollars
      • Total: 100,800 dollars

6. Shelf-stocking costs

      • Soft drinks, 216 stocking-hours times 20 dollars: 4,320 dollars
      • Fresh produce, 2,160 stocking-hours times 20 dollars: 43,200 dollars
      • Packaged food, 1,080 stocking-hours times 20 dollars: 21,600 dollars
      • Total: 69,120 dollars

7. Customer-support costs

      • Soft drinks, 50,400 items sold times 0.20 dollars: 10,080
      • Fresh produce, 441,600 items sold times 0.20 dollars: 88,320
      • Packaged food, 122,400 items sold times 0.20 dollars: 24,480
      • Total: 122,880

8. Total costs

      • Soft drinks: 283,200 dollars
      • Fresh produce: 835,200 dollars
      • Packaged food: 441,600 dollars
      • Total: 1,560,000 dollars

9. Operating income

      • Soft drinks: 34,200 dollars
      • Fresh produce: 5,040 dollars
      • Packaged food: 42,360 dollars
      • Total: 81,600 dollars

10. Operating income divided by revenues

      • Soft drinks: 10.78 percent
      • Fresh produce: 0.60 percent
      • Packaged food: 8.75 percent
      • Total: 4.97 percent
  1. 3. Managers believe the ABC system is more credible than the simple costing system. The ABC system distinguishes the different types of activities at FS more precisely. It also tracks more accurately how individual product lines use resources. Rankings of relative profitability—operating income as a percentage of revenues—of the three product lines under the simple costing system and under the ABC system are as follows:

Simple Costing SystemABC System
1. Fresh produce7.17%1. Soft drinks 10.78%
2. Packaged food3.30%2. Packaged food  8.75%
3. Soft drinks 1.70%3. Fresh produce 0.60%

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

<p>A table gives percentage of revenues, cost of goods sold, and activity costs for each of three product lines</p>

The table depicts revenues, cost of goods sold, bottle returns, and four different activity areas for soft drinks, fresh produce, and packaged food. The details of the table are as follows:

  1. Revenues
    • Soft drinks: 19.34 percent
    • Fresh produce: 51.18 percent
    • Packaged food: 29.48 percent
  1. Cost of goods sold
    • Soft drinks: 20.00 percent
    • Fresh produce: 50.00 percent
    • Packaged food: 30.00 percent
  1. Bottle returns
    • Soft drinks: 100.00 percent
    • Fresh produce: 0 percent
    • Packaged food: 0 percent
  1. Activity area: Ordering
    • Soft drinks: 23.08 percent
    • Fresh produce: 53.84 percent
    • Packaged food: 23.08 percent
  1. Activity area: Delivery
    • Soft drinks: 9.53 percent
    • Fresh produce: 69.52 percent
    • Packaged food: 20.95 percent
  1. Activity area: Shelf stocking
    • Soft drinks: 6.25 percent
    • Fresh produce: 62.50 percent
    • Packaged food: 31.25 percent
  1. Activity area: Customer support
    • Soft drinks: 8.20 percent
    • Fresh produce: 71.88 percent
    • Packaged food: 19.92 percent
  1. Soft drinks have fewer deliveries and require less shelf-stocking time and customer support than either fresh produce or packaged food. Most major soft-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 and so requires the most customer support. The simple 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. Relative to cost of goods sold, soft drinks and packaged food use fewer resources, while fresh produce uses more resources. As a result, the ABC system reduces the costs assigned to soft drinks and packaged food and increases the costs assigned to fresh produce. The simple costing system is an example of averaging that is too broad.
  2. FS managers can use the ABC information to guide decisions such as how to allocate a planned increase in floor space. An increase in the percentage of space allocated to soft drinks is warranted. Note, however, that ABC information is only one input into decisions about shelf-space allocation. In many situations, companies cannot make product decisions in isolation but must consider the effect that dropping or de-emphasizing a product might have on customer demand for other products. For example, FS will have a minimum limit on the shelf space allocated to fresh produce because reducing the choice of fresh produce will lead to customers not shopping at FS, resulting in loss of sales of other, more profitable products.
  3. 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 10.78% 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 simple costing system erroneously implied that soft drinks only had a 1.70% margin, leaving little room to counter a competitor’s pricing initiatives.