Question

Garner Industries manufactures precision tools. The firm uses an activity-based costing system. CEO Deb Garner is very proud of the accuracy of the system in determining product costs. She noticed that since the installment of the ABC system 10 years earlier the firm had become much more competitive in all aspects of the business and earned an increasing amount of profits every year

In the last two years the firm sold 0.628 million units to 4,100 customers each year. The manufacturing cost is $500 per unit. In addition, Garner has determined that the order-filling cost is $35.73 per unit. The $696.00 selling price per unit includes 16% markup to cover administrative costs and profits.

The order-filling cost per unit is determined based on the firm’s costs for order-filling activities. Order-filling capacity can be added in blocks of 60 orders. Each block costs $60,000. In addition, the firm incurs $1,200 order-filling costs per order.

Garner serves two types of customers designated as PC (Preferred Customer) and SC (Small Customer). Each of the 100 PCs buys, on average, 5,000 units in two orders. The firm also sells 128,000 units to 1,000 SCs. On average each SC buys 128 units in 10 orders. Ed Cheap, a buyer for one PC, complains about the high price he is paying. Cheap claims that he has been offered a price of $600 per unit and threatens to take his business elsewhere. Garner does not give in because the $600 price Cheap demands is below cost. Besides, she has recently raised the price to SC to $671.88 per unit and experienced no decline in orders. What would be the amount of loss (profit) per unit if Garner sells to Cheap at $600 per unit?​ (Note: The answer is not $99.12).

Answer 1

The answer is based on selling price of $696.00, which is considered for all calculation. The information about selling price rise to SCs to $671.88 is ignored since the original selling price is not given for SCs and if the original selling price was $696.00 to SCs also, then price cannot be increased to $671.88.

Cost component	Total Business	Cheap Business
Manufacturing cost per unit	$ 500.00	$ 500.00
Order-filling cost	$    35.73	$       0.48		SeeNote
Direct Cost	$ 535.73	$ 500.48
SG&A	$    64.27	$    64.27		See Note
Total operating cost	$ 600.00	$ 564.75
Price	$ 696.00	$ 600.00
Profit	$    96.00	$    35.25
mark-up %	16%	6%
Note
1. Total operating cost for Total business is calculated as below:
Selling Price *100/116 (considering 16% mark-up)
2. SG&A is the difference between Total cost less Direct Cost. The SG&A per unit for selling to Cheap will remain considering that allocation of SG&A cost on these units will be prudent to calculate the operatig profit
3. Order filling cost for ED's order is calculated as below:-
a) There is no impact on cost per block since the
change will be only 2 orders and no additional blocks
is required to cater Cheap
b) Therefore, cost is calculated only based on variable cost
which is 2 orders X $1200 per order/5000 orders

Calculation of Order filling cost. It is noted that cost of Order-filling to PCs and SCs should be different considering the cost components mainy the cost of blocks since the same is needed based on Volume.

Total orders	No of customer	order per customer	Total Order	unit per customer	Total Unit
PC	100	2	200	5,000	5,00,000
SC	1,000	10	10,000	128	1,28,000
			10,200		6,28,000
Total Blocks required			170	(total orders / 60)
Cost per block			$                  60,000
Total cost	(A)		$        1,02,00,000
Variable cost per order			$                    1,200
Total cost	(B)		$        1,22,40,000
Total cost of order filling			$        2,24,40,000	(A+B)
Cost per unit			$   35.73	(Total cost / Total units)