Textbook Problem

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Assign the customer-related activity costs to each customer type using activity rates. Now calculate the profitability of each customer category. As a manager, how would you use this information?

Emery Company sells small machine parts to heavy equipment manufacturers for an average price of $1.05 per part. There are two types of customers: those who place small, frequent orders and those who place larger, less frequent orders. Each time an order is placed and processed, a setup is required. Scheduling is also needed to coordinate the many different orders that come in and place demands on the plant’s manufacturing resources. Emery also inspects a sample of the products each time a batch is produced to ensure that the customer’s specifications have been met Inspection takes essentially the same time regardless of the type of part being produced. Emery’s Cost Accounting Department has provided the following budgeted data for customer-related activities and costs (the amounts expected for the coming year):

Required:

1. 1. Assign the customer-related activity costs to each category of customers in proportion to the sales revenue earned by each customer type. Calculate the profitability of each customer type. Discuss the problems with this measure of customer profitability.

To determine

Compute the profitability of each customer type. Explain the problems with this measure of customer profitability.

Explanation of Solution

Calculate sales revenue for each customer.

$\begin{array}{c}\text{Sales Revenue}=\text{Average price}\times \text{Total sales order}\\ \text{=\$1}\text{.05}\times \text{44,100,000}\\ \text{=\$46,305,000}\end{array}$

Note: The total number of parts is the average order size times the number of sales order.

Therefore, the total customer related activity costs are split equally:

$\begin{array}{c}\text{Cost Allocation}=\frac{\text{Total customer related activity}}{2}\\ =\frac{12,390,000}{2}\\ =\$6,195,000\end{array}$

The profitability of each category is calculated as follows:

Particulars	Amount ($)
Sales revenue	46,305,000
Less: Noncustomer-related cost (1)	24,696,000
Customer-related activity costs	6,195,000
Customer profitability	15,414,000

TABLE (1)

Working Note:

(1) Calculate the noncustomer-related cost

To determine

Compute the profitability of each customer category and explain how this information is used as a manager by assigning the customer-related activity costs to each customer type using activity rates.