Question

Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 8%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $108 to purchase these supplies.

For years, Worley believed that the 8% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits, Worley decided to implement an activity-based costing system to help improve its understanding of customer profitability. The company broke its selling and administrative expenses into five activities as shown:

Activity Cost Pool (Activity Measure)	Total Cost		Total Activity
Customer deliveries (Number of deliveries)	$	249,000	3,000	deliveries
Manual order processing (Number of manual orders)		280,000	4,000	orders
Electronic order processing (Number of electronic orders)		242,000	11,000	orders
Line item picking (Number of line items picked)		700,000	400,000	line items
Other organization-sustaining costs (None)		640,000
Total selling and administrative expenses	$	2,111,000

Worley gathered the data below for two of the many hospitals that it serves—University and Memorial (each hospital purchased medical supplies that had cost Worley $37,000 to buy from manufacturers):

	Activity
Activity Measure	University	Memorial
Number of deliveries	13	22
Number of manual orders	0	46
Number of electronic orders	13	0
Number of line items picked	150	220

Required:

1. Compute the total revenue that Worley would receive from University and Memorial.

2. Compute the activity rate for each activity cost pool.

3. Compute the total activity costs that would be assigned to University and Memorial.

4. Compute Worley’s customer margin for University and Memorial. (Hint: Do not overlook the $37,000 cost of goods sold that Worley incurred serving each hospital.)

Answer 1

1
	Total revenue
University	39960	=37000*1.08	=37000*1.08
Memorial	39960	=37000*1.08	=37000*1.08
2
Activity Cost Pool	Activity rate
Customer deliveries	83	per delivery	=249000/3000
Manual order processing	70	per manual order	=280000/4000
Electronic order processing	22	per electronic order	=242000/11000
Line item picking	1.75	per line item	=700000/400000
3
	University			Memorial
Activity Cost Pool	Activity	Activity rate	Activity cost	Activity	Activity rate	Activity cost
Customer deliveries	13	83	1079	22	83	1826
Manual order processing	0	70	0	46	70	3220
Electronic order processing	13	22	286	0	22	0
Line item picking	150	1.75	262.5	220	1.75	385
		Total	1627.5			5431
	Total activity costs
University	1627.5
Memorial	5431
4
	Customer margin
University	1332.5	=39960-37000-1627.5
Memorial	-2471	=39960-37000-5431