Question

Supermart Food Stores (SFS) has experienced net operating losses in its frozen food products line in the last few periods. Management believes that the store can improve its profitability if SFS discontinues frozen foods. The operating results from the most recent period are:

	Frozen Food	Baked Food	Fresh Food
Sales	$120.000	$91,000	$158,175
Direct Costs	105,000	67,000	110,000

SFS is currently estimating manufacturing overhead costs as 20% of revenues. The controller says that not every dollar of sales requires the same amount of manufacturing overhead activities. A preliminary analysis revealed the indirect overhead activities for the three product lines are:

	Cost Drivers	Cost per item	Frozen Food	Baked food	Fresh Food
Order Processing	# of purchase orders	$80/ purchase order	10	45	100
Receiving	#of deliveries	$110/delivery	12	55	120
Self Stocking	# of hours per delivery	$15.25/hour	2	0.5	4
Customer support	Items sold	$0.21/item	30,000	40,000	86,000

Required:

1. Prepare a profitability report showing the profit for each product line for SFS under the current costing system.
2. Prepare a profitability report showing the profit for each product line for SFS under the Activity Based Costing system.
3. Comment on the changes in company’s profitability. Do you advice SFS management to discontinue the frozen foods line.

Answer 1

Solution :

(1) Profitability Reort under Current Costing :

Particulars	Frozen Foods	Baked Foods	Fresh Foods
(a) Sales	$ 120,000	$ 91,000	$ 158,175
(b) Cost of Goods Sold	$ 105,000	$ 67,000	$ 110,000
(c) Gross Margin ( a - b)	$ 15,000	$ 24,000	$ 48,175
(d) Store Support Expenses (a * 20%)	$ 24,000	$ 18,200	$ 31,635
(e) Operating Income (loss) (c - d)	($ 9,000)	$ 5,800	$ 16,540
(f) Operating Income (loss) (e / a)	(7.50) %	6.37%	10.46%

(1) Profitability Reort under Activity Based Costing :

Particulars	Frozen Foods	Baked Foods	Fresh Foods
(a) Sales	$ 120,000	$ 91,000	$ 158,175
(b) Cost of Goods Sold	$ 105,000	$ 67,000	$ 110,000
(c) Gross Margin ( a - b)	$ 15,000	$ 24,000	$ 48,175
Store Support Expenses :
(d) Order Processing (No. of Purchases Orders * $ 80)	$ 800	$ 3,600	$ 8,000
(e) Receiving (No. of Deliveries * $ 110)	$ 1,320	$ 6,050	$ 13,200
(f) Self Stocking ( No. of Deliveries * No. of Hour Per Delivery * $ 15.25)	$ 366	$ 419	$ 7,320
(g) Cutomer Support (No. of Item Sold * $ 0.21)	$ 6,300	$ 8,400	$ 18,060
(h) Total Support Cost (d + e + f + g)	$ 8,786	$ 18,469	$ 46,580
(i) Operating Income (loss) (c - h)	$ 6,214	$ 5,531	$ 1,595
(f) Operating Income (loss) (i / a)	5.18%	6.08%	1.01%

Comment : There is huge difference in profitability of Frozen Foods and Fresh Foods as per current costing and as per ABC costing system. Company must analyse closely the no. the activities actually performed in Frozen Foods and Fresh Foods and then allocate the same after analysis. It is not advisable to discontinue Frozen Food Line till the actual cost analysis.

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