Question

Alex Home Supplies Inc. is specialized in selling paint, carpet, and flooring supplies. Company has experienced net operating losses in its Flooring Supplies line during the last few periods. Company management team thinks that the store will improve its profitability if it discontinued the Flooring Supplies line. The operating results from the most recent period are as follows.

Currently, the store support expenses are allocated among the three product line based on sales dollars of the product lines.

Product Profitability Analysis                  Paint Supplies                 Carpet Supplies               Flooring Supplies             Total

Sales                                                          $295,000                           $214,900                        $167,900                      $677,800

Cost of goods sold                                     ($165,000)                        ($150,000)                     ($135,250)                    ($450,250)

Gross Profit                                                $130,000                            $64,900                          $32,650                       $227,550

Store support expenses (S & A)                 ($70,800)                          ($51,576)                       ($40,296)                     ($162,672)

Product line operating income (loss)          $59,200                             $13,324                          ($7,646)                        $64,878

Product line profit margin ratio                    20.07%                               6.20%                            -4.55%                           9.57%

Lisa, the new accountant who is a graduate of CSU, believes that not every sales dollar requires or uses the same amount of store support activities. She believes that company should look for other means for the allocation of store support expenses among the three product lines – such as Activity Based Costing. Her preliminary investigation and analysis results are as follows:

Store Support Activities                            Activity Cost                                 Suggested Cost Driver

Customer Order Processing                        $94,500                                      Number of orders placed

Receiving                                                     41,400                                        Number of deliveries

Customer Support                                        26,772                                        Sales Hours

Total store support expenses                       162,672

She also has compiled the following additional data in regard to usage of activities by the three product lines:

                                                                                                                                                   Paint Supplies              Carpet Supplies                  Flooring Supplies

Order processing (number of sales orders)                                                                                    425                                   150                                      100

Receiving (number of deliveries)                                                                                                      50                                    120                                       60

Customer support (hours required per sales order)                                                                         0.50                                  8.00                                     0.75

Requirements:

a. Complete the table on the Answers Sheet by allocation store support expenses using Lisa’s proposed activity based costing.

b. Should Alex Home Supplies Inc. discontinue the Flooring Supplies line? Why?

Answer 1

a) Allocation of support expenses using activity based costing

	Paint supplies	Carper supplies	Flooring supplies	Total cost drivers	Activity cost	Cost per activity
Customer order processing	425	150	100	675	$94,500	$140
Receiving	120	60	50	230	$41,400	$180
Customer support	213	1,200	75	1,488	$26,772	$18

Allocation of support costs

	Paint supplies	Carper supplies	Flooring supplies
Customer order processing	$59,500	$21,000	$14,000
Receiving	$21,600	$10,800	$9,000
Customer support	$3,825	$21,598	$1,350
Total	$84,925	$53,398	$24,350

The product profitability analysis using the activity based costing:

	Flooring supplies	Paint supplies	Carper supplies	Total
Sales	$1,67,900	$2,95,000	$2,14,900	$6,77,800
Cost of goods sold	$1,35,250	$1,65,000	$1,50,000	$4,50,250
Gross profit	$32,650	$1,30,000	$64,900	$2,27,550
Store suport expenses	$24,350	$84,925	$53,398	$1,62,672
Product line operating income/(loss)	$8,300	$45,075	$11,502	$64,878
Product line profit margin ratio	4.94%	15.28%	5.35%	9.57%

b) No, Alex Home Supplies should not discontinue the Flooring Supplies line becuase the line is generating a profit margin ratio of 4.94%. This has been possible due to accurate allocation of store support expenses. Rather all the product lines are profitable after the allocations.