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)	$	344,000	4,000	deliveries
Manual order processing (Number of manual orders)		616,000	8,000	orders
Electronic order processing (Number of electronic orders)		286,000	13,000	orders
Line item picking (Number of line items picked)		940,000	470,000	line items
Other organization-sustaining costs (None)		610,000
Total selling and administrative expenses	$	2,796,000

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 $33,000 to buy from manufacturers):

	Activity
Activity Measure	University	Memorial
Number of deliveries	16	27
Number of manual orders	0	43
Number of electronic orders	15	0
Number of line items picked	140	230

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 $33,000 cost of goods sold that Worley incurred serving each hospital.)

Answer 1

Requirement 1:

Compute the total revenue that Worley would receive from University and Memorial as follows:

Total revenue = Cost of goods sold + 5% mark-up

= $33000 + 5% of $33000

= $33000 + $1650

= $34650.

Therefore, the total revenue that worley would receive from University and Memorial is $34650.

Requirement 2:

Compute the activity rate for each activity cost pool as follows:

Activity cost pool	Activity measure	Total Cost	Total activity	Activityrate
Customer deliveries	No.of deliveries	344000	4000	$86
Mannual order processing	No.of manual orders	616000	8000	$77
Electronic order processing	No. of electronic orders	286000	13000	$22
Line item picking	No.of line items picked	940000	470000	$2

Workings:

Activity rate = Totao cost / Total activity

= 344000 / 4000 = $86 per delivery

= 616000 / 8000 = $77 per manual order

= 28600 / 13000 = $22 per electronic order

= 940000 / 470000 = $2 per line iteam picked.

Requirement 3:

Compute the total activity costs that would be assigned to University and Memorial as follows:

		University	Memorial
Activity cost pool	Activity Rate	Total activity	Total Cost	Total activity	Total Cost
Customer deliveries	$86	16	$1376	27	$2322
Manual order processing	$77	0	$0	43	$3311
Electronic order processing	$22	15	$330	0	$0
Line item picking	$2	140	$280	230	$460
Total activity costs	$1986		$6093

Workings:

Total cost = Total activity Activity rate.

University:

8616= $1376

770= $0

22​​​​​​​15= $330

2​​​​​​​140= $280

Memorial:

8627= $2322

77​​​​​​​43= $3311

22​​​​​​​0= $0

2​​​​​​​230= $460.

Requirement 4:

Compute Worley's customer margin for university and memorial as follows:

Details	University	Memorial
Revenue(from requirement 1)	$34650	$34650
Loss: Cost of goods sold (given as hint)	$33000	$33000
Gross margin	$1650	$1650
Less: Activity costs(from requirement 3)	$1986	$6093
Customer margin	($336)	($4443)

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