Question

Super Bookstore is a large city bookstore that sells books and music CDs and has a café. Super Bookstore operates at capacity and allocates selling, general, and administration (S, G, and A) costs to each product line using the cost of merchandise of each product line. Super Bookstore wants to optimize the pricing and cost management of each product line. The bookstore is wondering whether its accounting system is providing it with the best information for making such decisions.

Super Bookstore Product Line Information for the Year Ended December 31, 2012

	BOOKS	CDs	Cafe
Revenues	$3,720,480	$2,315,360	$736,216
Cost of Merchandise	$2,656,272	$1,722,311	$556,685
Cost of cafe cleaning	--	--	$18,250
Number of purchase orders	2800	2500	2000
Number of deliveries recieved	1400	1700	1600
Hours of shelf stocking time	1500	1400	1000
Items sold	12016	115768	368108

Super Bookstore incurs the following S, G, and A costs.

Purchasing Department expenses	$474,500
Receiving department expenses	$432,400
Shelf stocking labor expense	$487,500
Customer support expence (cashiers and floor employess)	$91,184
TOTAL	$1,485,584

Based on the data, solve the following problems: a. Suppose Super Bookstore uses the cost of merchandise to allocate all S, G, and A costs. Prepare product line and total company income statements. b. Explain an improved method for allocating costs to the three product lines. Use the method for allocating S, G, and A costs that you propose to prepare new product line and total company income statements. Compare your results with the results in Problem a. c. Write a memo to Super Bookstore’s management describing how the improved system might be useful for managing Super Bookstore. Submission Requirements:  Use MS Excel workbook to show the supporting analysis. For memo, use the textbox in the MS Excel workbook.  Show the detailed steps that you performed to solve the problem.

Answer 1

a. Existing system :

Income Statement For the year ended December 31, 2012
	Books	CDs	Cafe	Company
Revenues	$ 3,720,480	$ 2,315,360	$ 736,216	$ 6,772,056
Cost of Merchandise	2,656,272	1,722,311	556,685	4,935,268
Gross Margin	1,064,208	593,049	179,531	1,836,788
Cost of Cafe Cleaning	-	-	18,250	18,250
S,G & A Costs	799,575	518,439	167,570	1,485,584
Net Income	$ 264,633	$ 74,610	$ (6,289)	$ 332,954

b. Since each product line consumes S, G & A activities in different proportions, costs should be allocated on the basis on activities consumed. In other words, the system of Activity Based Costing should be used for S,G & A cost allocation.

Income Statement For the year ended December 31, 2012
	Books	CDs	Cafe	Company
Revenues	$ 3,720,480	$ 2,315,360	$ 736,216	$ 6,772,056
Cost of Merchandise	2,656,272	1,722,311	556,685	4,935,268
Gross Margin	1,064,208	593,049	179,531	1,836,788
Cafe cleaning costs	-	-	18,250	18,250
S, G & A costs
Purchasing department expenses ( allocation base: number of purchase orders)	182,000	162,500	130,000	474,500
Receiving department expenses ( allocation base: number of deliveries received)	128,800	156,400	147,200	432,400
Shelf stocking labor expense ( allocation base : hours of shelf stocking time)	187,500	175,000	125,000	487,500
Customer support expense ( allocation base: number of items sold )	2,210	21,287	67,687	91,184
Total S, G & A expenses	500,510	515,187	469,887	1,485,584
Net income	$ 563,698	$ 77,862	$(308,606)	$ 332,954

While the net income for Books was understated by $ 299,065, net loss for Cafe was understated by $ 302,317. This is because, S,G & A costs are over-allocated to for Books, and under-allocated to Cafe. Cafe's consumption of S,G & A related activities is much higher than that of Books. Therefore, cost allocation to Cafe should also be higher than Books. But under the existing system, the opposite is happening.

c. The current accounting system is not generating accurate cost information, and as a result, leading to poor pricing decisions.  Books seem to be overpriced, leading to modest sales volume, and low market share. On the other hand, the items of Cafe are being hugely underpriced. Therefore, while sales volume is very high, Cafe's profitability is very poor.

The improved system would help in generating more accurate cost information, leading to better pricing decisions. This would help to increase sales volume for Books, and improve profitability for Cafe.