Question

Construct and Interpret a Product Profitability Report, Allocating Selling and Administrative Expenses

Naper Inc. manufactures power equipment. Naper has two primary products—generators and air compressors. The following report was prepared by the controller for Naper's senior marketing management for the year ended December 31:

	Generators		Air Compressors			Total
Revenue	$4,200,000			$3,000,000		$7,200,000
Cost of goods sold	2,940,000			2,100,000		5,040,000
Gross profit	$1,260,000			$900,000		$2,160,000
Selling and administrative expenses						610,000
Income from operations						$1,550,000

The marketing management team was concerned that the selling and administrative expenses were not traced to the products. Marketing management believed that some products consumed larger amounts of selling and administrative expense than did other products. To verify this, the controller was asked to prepare a complete product profitability report, using activity-based costing.

The controller determined that selling and administrative expenses consisted of two activities: sales order processing and post-sale customer service. The controller was able to determine the activity base and activity rate for each activity, as follows:

Activity	Activity Base			Activity Rate
Sales order processing	Sales orders		$65	per sales order
Post-sale customer service	Service requests		$200	per customer service request

The controller determined the following activity-base usage information about each product:

	Generators		Air Compressors
Number of sales orders	3,000		4,000
Number of service requests	225		550

a. Determine the activity cost of each product for sales order processing and post-sale customer service activities.

	Sales Order Processing Activities Cost		Post-sale Customer Service Activities Cost
Generators	$		$
Air Compressors
Total	$		$

b. Use the information in (a) to prepare a complete product profitability report dated for the year ended December 31. Calculate the gross profit to sales and the income from operations to sales percentages for each product. Round percentages to two decimal places. Enter all amounts as positive numbers.

Naper Inc.
Product Profitability Report
For the Year Ended December 31
	Generators	Air Compressors	Total
Revenues	$	$	$
Cost of goods sold
Gross profit	$	$	$
Sales order processing	$	$	$
Post-sale customer service
Total selling and administrative expense	$	$	$
Income from operations	$	$	$
Gross profit as a percentage of sales	%	%
Income from operations as a percentage of sales	%	%

c. Interpret the product profitability report.

The air compressors have the lower  income from operations to sales percentage because the product is a heavy  user of Naper’s sales and service activities. Many factors cause the air compressors to have less  income from operations as a percent of sales than generators.

Answer 1

a. Determine the activity cost of each product for sales order processing and post-sale customer service activities.

Generators		Air Compressors
Number of sales orders	3,000		4,000
Number of service requests	225		550

1) Sales Order Processing Activities Cost : (Number of sales orders/ Number of service requests)*Sales orders

a) Generators : (3,000/225)*$65   

: $866.67

b) Air Compressors : (4,000/550)*$65

: $472.73

2) Post-sale Customer Service Activities Cost : (Number of sales orders/ Number of service requests)*Service requests

a) Generators : (3,000/225)*$200

: $2666.67

b) Air Compressors : (4,000/550)*$200

: $1454.55

  

	Sales Order Processing Activities Cost		Post-sale Customer Service Activities Cost
Generators	$ 866.67		$ 2,666.67
Air Compressors	$ 472.73		$ 1,454.55
Total	$ 1,339.4		$ 4,121.22

b. Use the information in (a) to prepare a complete product profitability report dated for the year ended December 31. Calculate the gross profit to sales and the income from operations to sales percentages for each product. Round percentages to two decimal places. Enter all amounts as positive numbers.

Naper Inc.
Product Profitability Report
For the Year Ended December 31
	Generators	Air Compressors	Total
Revenues	$4,200,000	$3,000,000	$7,200,000
Cost of goods sold	2,940,000	2,100,000	5,040,000
Gross profit	$1,260,000	$ 900,000	$2,160,000
Sales order processing	$ 866.67	$ 472.73	$ 1,339.4
Post-sale customer service	$2,666.67	$1,454.55	$4,121.22
Total selling and administrative expense	$	$	$610,000
Income from operations	$	$	$1,550,000
Gross profit as a percentage of sales	%	%	30%
Income from operations as a percentage of sales	%	%

Note : a) Gross profit  as a percentage of sales

: Gross profit = (total sales - cost of goods sales)/total sales

= ($7,200,000 - $5,040,000)/$7,200,000

= $2,160,000/$7,200,000

= 0.3 or 30%

: b) Operating Income = Revenue - Cost of Goods Sold (COGS) - Labor, and other day-to-day expenses

= $ 7,200,000 - $5,040,000 - $610,000

= $ 1,550,000

  Income from operations as a percentage of sales = operating income/total sales

= $ 1,550,000/$ 7,200,000

= 0.22 or 22%

c. Interpret the product profitability report.

The air compressors have the lower  income from operations to sales percentage because the product is a heavy  user of Naper’s sales and service activities. Many factors cause the air compressors to have less  income from operations as a percent of sales than generators.

This statement is correct