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)	$	320,000	4,000	deliveries
Manual order processing (Number of manual orders)		365,000	5,000	orders
Electronic order processing (Number of electronic orders)		230,000	10,000	orders
Line item picking (Number of line items picked)		877,500	450,000	line items
Other organization-sustaining costs (None)		690,000
Total selling and administrative expenses	$	2,482,500

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 $35,000 to buy from manufacturers):

	Activity
Activity Measure	University	Memorial
Number of deliveries	17	25
Number of manual orders	0	41
Number of electronic orders	18	0
Number of line items picked	160	280

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 $35,000 cost of goods sold that Worley incurred serving each hospital.)

Answer 1

1.

	Total Revenue
University	$37800
Memorial	$37800

$35000 x 1.08 = $37800

2.

Activity Cost Pool	Total Cost $	Total Activity		Activity Rate
Customer deliveries	320000	4000	deliveries	80.00	per delivery
Manual order processing	365000	5000	orders	73.00	per manual order
Electronic order processing	230000	10000	orders	23.00	per electronic order
Line item pricing	877500	450000	line items	1.95	per line item picked

3.

	Total Activity Costs
University	$2086
Memorial	$5539

	Activity Rate $	University		Memorial
		Activity Usage	Cost $	Activity Usage	Cost $
Customer deliveries	80.00	17	1360	25	2000
Manual order processing	73.00	0	0	41	2993
Electronic order processing	23.00	18	414	0	0
Line item pricing	1.95	160	312	280	546
Total activity cost			2086		5539

4.

	Customer Margin
University	$714
Memorial	-$2739

University = $37800 - $35000 - $2086 = $714

Memorial = $37800 - $35000 - $5539 = -$2739