Question

Activity-Based Costing and Customer Profitability

Schneider Electric manufactures power distribution equipment for commercial customers, such as hospitals and manufacturers. Activity-based costing was used to determine customer profitability. Customer service activities were assigned to individual customers, using the following assumed customer service activities, activity base, and activity rate:

Customer Service Activity	Activity Base	Activity Rate
Bid preparation	Number of bid requests	$400 per request
Shipment	Number of shipments	$ 80 per shipment
Support standard items	Number of standard items ordered	$ 25 per std. item
Support nonstandard items	Number of nonstandard items ordered	$150 per nonstd. item

Assume that the company had the following gross profit information for three representative customers:

	Customer 1			Customer 2			Customer 3
Revenues		$120,000			$200,000			$160,000
Cost of goods sold		76,800			110,000			83,200
Gross profit		$43,200			$90,000			$76,800
Gross profit as a percent of sales		36%			45%			48%

The administrative records indicated that the activity-base usage quantities for each customer were as follows:

Activity Base	Customer 1	Customer 2	Customer 3
Number of bid requests	14	38	55
Number of shipments	30	60	48
Number of standard items ordered	15	30	50
Number of nonstandard items ordered	5	70	80

a. Prepare a customer profitability report dated for the year ended December 31, 20Y8, showing (1) the income from operations after customer service activities, (2) the gross profit as a percent of sales, and (3) the income from operations after customer service activities as a percent of sales. Prepare the report with a column for each customer. Round percentages to the nearest whole percent. Enter all amounts as positive numbers.

Schneider Electric
Customer Profitability Report
For the Year Ended December 31, 20Y8
	Customer 1	Customer 2	Customer 3
Revenues	$	$	$
Cost of goods sold
Gross profit	$	$	$
Customer service activities:
Bid preparation	$	$	$
Shipment
Support standard items
Support nonstandard items
Total customer service activities	$	$	$
Income from operations after customer service activities	$	$	$
Gross profit as a percent of sales	%	%	%
Income from operations after customer service activities as a percent of sales	%	%	%

b. Interpret the report in part (a).

The gross profit as a percent of sales indicated that was the least profitable, while was the most profitable. After deducting the activity costs associated with customer service activities, became the least profitable, while became nearly as profitable as Customer 2. The reason is because consumed much more customer service activities than did the other customers. Apparently, ordered nonstandard products that required specialized bid requests. In addition, required more shipments, indicating smaller shipments to a customer’s location, rather than a few large shipments.

Answer 1

Schneider Electric
Customer Profitability Report
For the Year Ended December 31, 20Y8
	Customer 1	Customer 2	Customer 3
Revenues	120000	200000	160000
Cost of goods sold	76800	110000	83200
Gross profit	43200	90000	76800
Customer service activities:
Bid preparation	5600	15200	22000
Shipment	2400	4800	3840
Support standard items	375	750	1250
Support nonstandard items	625	10500	12000
Total customer service activities	9000	31250	39090
Income from operations after customer service activities	34200	58750	37710
Gross profit as a percent of sales	36	45	48
Income from operations after customer service activities as a percent of sales	28.5	29.4	23.6

The gross profit as a percent of sales indicated that Customer 1 was the least profitable, while Customer 3 was the most profitable. After deducting the activity costs associated with customer service activities, Customer 3 became the least profitable, while Customer 1 became nearly as profitable as Customer 2. The reason is because Customer 3 consumed much more customer service activities than did the other customers. Apparently, Customer 1 ordered nonstandard products that required specialized bid requests. In addition, Customer 2 required more shipments, indicating smaller shipments to a customer’s location, rather than a few large shipments.