Question

Ellie Mosk, CEO of X-Space Industries, decided to expand the company’s product offering beyond the core model rocket business. After investigation, she decided to set up a separate division to design and manufacture products for the drone market. Several companies were interested in having X-Space develop these drones, and financial results, to date, have been encouraging. Revenue was $4 million, gross margins have been running about 40%, and the customer sales and support costs were $1 million. However, there is a growing concern that some customers require a disproportionate share of the sales and support resources, and the true profitability of the customers is unknown. Data were collected to support an analysis of customer profitability: Activity Cost Driver Total Cost Sales visits Sales visit days $ 491,000 Product modifications Number of modifications 275,000 Phone calls Number of minutes 93,500 E-mail/electronic communications Number of communications 177,000 $ 1,036,500 Customer Revenue Gross Profit Visit Days Modifications Phone Minutes Electronic Communications A $ 405,000 $ 155,000 15 15 1,180 625 B 505,000 205,000 25 15 1,270 875 C 605,000 235,000 40 40 1,520 1,150 D 1,150,000 425,000 90 60 1,870 2,150 E 1,550,000 595,000 100 70 2,270 2,400 Totals $ 4,215,000 $ 1,615,000 270 200 8,110 7,200 Required: 1. Management felt the easiest way to allocate the sales and support costs was based on the total revenue. Using total revenue as the allocation base, determine the profitability of each of the five customers. 2. Management felt that because the data revealed some customers require a disproportionate share of sales and support resources, activity-based costing should be used to determine customer profitability. Use ABC to prepare a customer profitability analysis.

Answer 1

In the Question above we need to allocate the Support function( SFC ) in two different ways. The Revenue and Margin is already given. First process of allocation is on the base of Revenue so what we do is we allocate the SFC total on the revenue % of a customer compare to the total revenue ie A Customer with higher revenue will get higher allocation and vice versa.

	A	B	C ( example - 405000/4215000	D= 1036500( total Support function cost ) X C	E= A-D	F=( Example 305407/3178500
Customer	Revenue	Gross Profit	Revenue % of Total revenue	Support function	Profit after Support cost allocation	Profit %
A	405000	155000	10%	99593	55407	10%
B	505000	205000	12%	124183	80817	14%
C	605000	235000	14%	148774	86226	15%
D	1150000	425000	27%	282794	142206	25%
E	1550000	595000	37%	381157	213843	37%
Total	4215000	1615000	100%	1036500	578500	14%

Second method is ABC that is activity based costing where we will arrive at cost to be allocation based on the ratio/appropration of activities done and accordingly the total cost is broken. One thing is to note here that we are not actually arrving at the actual cost per customer as we are breaking the Actual total cost based on the activity and the cost of one activity in acutal could vary from case to case.

Customer	Visits Per day	Modifications	Phone minutes	Electronic Communications
A	15	15	1180	625
B	25	15	1270	875
C	40	40	1520	1150
D	90	60	1870	2150
E	100	70	2270	2400
Total	270	200	8110	7200
Total Cost	491000	275000	93500	177000	1036500
A	27278	20625	13604	15365	76872
B	45463	20625	14642	21510	102240
C	72741	55000	17524	28271	173536
D	163667	82500	21559	52854	320580
E	181852	96250	26171	59000	363273

	A	B	D= Working above	E= A-D	F=( Example 305407/3178500
Customer	Revenue	Gross Profit	Support function	Profit after Support cost allocation	Profit %
A	405000	155000	76872	78128	14%
B	505000	205000	102240	102760	18%
C	605000	235000	173536	61464	11%
D	1150000	425000	320580	104420	18%
E	1550000	595000	363273	231727	40%
Total	4215000	1615000	1036500	578500	100%