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 6%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $106 to purchase these supplies.

For years, Worley believed that the 6% 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)	$	602,000	7,000	deliveries
Manual order processing (Number of manual orders)		420,000	6,000	orders
Electronic order processing (Number of electronic orders)		252,000	12,000	orders
Line item picking (Number of line items picked)		765,000	450,000	line items
Other organization-sustaining costs (None)		660,000
Total selling and administrative expenses	$	2,699,000

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	13	25
Number of manual orders	0	43
Number of electronic orders	18	0
Number of line items picked	170	260

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

Solution 1:

Rveneue to be received form University and memorial = Cost of goods sold +6%

= $37,000 + $37000*6% = $39,220 from each hospital

Solution 2 & 3:

Computation of Activity rate and allocation of activity cost to hospital
Activity Cost Pool	Activity Measure	Estimated overhead cost	Total activity	Activity Rate	University		Memorial
					Activity	Activity Cost	Activity	Activity Cost
Customer deliveries	Nos of deliveries	$602,000.00	7000	$86.00	13	$1,118.00	25	$2,150.00
Manual order processing	Nos of manual orders	$420,000.00	6000	$70.00	0	$0.00	43	$3,010.00
Electronic order processing	Nos of electronic orders	$252,000.00	12000	$21.00	18	$378.00	0	$0.00
Line item picking	Number of line items picked	$765,000.00	450000	$1.70	170	$289.00	260	$442.00
Total		$2,039,000.00				$1,785.00		$5,602.00

Solution 4:

Worely's customer margin for:

University = $39,220 - $37,000 - $1,785 = $435

Memorial = $39,220 - $37,000 - $5,602 = -$3,382