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 5%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $105 to purchase these supplies.

For years, Worley believed that the 5% 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)	$	348,000	4,000	deliveries
Manual order processing (Number of manual orders)		497,000	7,000	orders
Electronic order processing (Number of electronic orders)		270,000	15,000	orders
Line item picking (Number of line items picked)		1,080,000	480,000	line items
Other organization-sustaining costs (None)		630,000
Total selling and administrative expenses	$	2,825,000

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	17	26
Number of manual orders	0	49
Number of electronic orders	16	0
Number of line items picked	100	300

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 = Cost of goods sold + 5%mark up

= $37,000 + 5% of 37,000

= 37000 + 1850 = $38,850

(2) Compute the activity rate for each activity cost pool as shown:

Activity cost Pool	Total cost	Total activity	Activity Rate
(a)	(b)	(c)	(b / c )
Customer deliveries	348,000	4,000	$87 per delivery
Manual order processing	497,000	7,000	$71 per manual order
Electronic order processing	270,000	15,000	$18 per electronic order
Line item Picking	1,080,000	480,000	$2.25 per line item picked

(3) Compute the activity for each activty cost pool.

Activity cost pool	Activity Rate	University		Memorial
		Total activity	Total cost	Total activity	Total cost
(a)	(b)	(c)	(d) = b*c	(e)	(f)= b*e
Customer deliveries	$87	17	$1,479	26	$2,262
Manual order processing	$71	0	$0	49	$3479
Electronic order processing	$18	16	$288	0	$0
Line item Picking	$2.25	100	$ 225	300	$675
Total activity Costs			$1,992		$6416

Hence total activity cost assigned to University is $1,992 and Memorial is $6416

(4) Customer margin for university and memorial.

Details	University	Memorial
Revenue	$38,850	$38,850
Less: Cost of goods sold	$37,000	$37,000
Gross margin	$1,850	$1,850
Less:Activity Costs	$1,992	$6416
Customer margin	($142)	($4,566)

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