Question

Ellie Mosk, CEO of X-Space Industries, decided to expand the company’s product offering beyond the core model rocket business. After investigation, she decided to set up a separate division to design and manufacture products for the drone market. Several companies were interested in having X-Space develop these drones, and financial results, to date, have been encouraging. Revenue was $4 million, gross margins have been running about 40%, and the customer sales and support costs were $1 million. However, there is a growing concern that some customers require a disproportionate share of the sales and support resources, and the true profitability of the customers is unknown. Data were collected to support an analysis of customer profitability: Activity Cost Driver Total Cost Sales visits Sales visit days $ 478,000 Product modifications Number of modifications 268,000 Phone calls Number of minutes 92,800 E-mail/electronic communications Number of communications 170,000 $ 1,008,800 Customer Revenue Gross Profit Visit Days Modifications Phone Minutes Electronic Communications A $ 392,000 $ 142,000 15 15 1,110 625 B 492,000 192,000 25 15 1,200 875 C 592,000 222,000 40 40 1,450 1,080 D 1,080,000 412,000 90 60 1,800 2,080 E 1,420,000 582,000 100 70 2,200 2,330 Totals $ 3,976,000 $ 1,550,000 270 200 7,760 6,990 Required: 1. Management felt the easiest way to allocate the sales and support costs was based on the total revenue. Using total revenue as the allocation base, determine the profitability of each of the five customers. 2. Management felt that because the data revealed some customers require a disproportionate share of sales and support resources, activity-based costing should be used to determine customer profitability. Use ABC to prepare a customer profitability analysis.

Answer 1

Activity	Activity Cost Driver	Total Cost
Sales Visit	Sales Visit days	$478,000
Product Modification	Number of modifications	$268,000
Phone Calls	Number of minutes	$92,800
E-mail/Electronic communication	Number of communications	$170,000
		$1,008,800
Customer	Revenue	Gross Profit	Visit Days	Modifications	Phone minutes	Communications
A	$392,000	$142,000	15	15	1110	625
B	$492,000	$192,000	25	15	1200	875
C	$592,000	$222,000	40	40	1450	1080
D	$1,080,000	$412,000	90	60	1800	2080
E	$1,420,000	$582,000	100	70	2200	2330
Total	$3,976,000	$1,550,000	270	200	7,760	6,990
Allocation of Sales and support cost based on total revenue
Customer	Revenue	Gross Profit	Sales and Support cost	Net Profit
A	$392,000	$142,000	$99,459	$42,541
B	$492,000	$192,000	$124,831	$67,169
C	$592,000	$222,000	$150,204	$71,796
D	$1,080,000	$412,000	$274,020	$137,980
E	$1,420,000	$582,000	$360,286	$221,714
Total	$3,976,000	$1,550,000	$1,008,800	$541,200
Sales and support cost allocation = Revenue for customer/total revenue x Sales and support cost
Allocation of Sales and support cost based on ABC
Customer	Sales Visit	Product Modification	Phone Calls	Email/Electronic Communications	Total
A	$26,556	$20,100	$13,274	$15,200	$75,130
B	$44,259	$20,100	$14,351	$21,280	$99,990
C	$70,815	$53,600	$17,340	$26,266	$168,021
D	$159,333	$80,400	$21,526	$50,587	$311,846
E	$177,037	$93,800	$26,309	$56,667	$353,813
Total	$478,000	$268,000	$92,800	$170,000	$1,008,800
Profitability of each customer based on ABC analysis
Customer	Revenue	Gross Profit	Sales and Support cost	Net Profit
A	$392,000	$142,000	$75,130	$66,870
B	$492,000	$192,000	$99,990	$92,010
C	$592,000	$222,000	$168,021	$53,979
D	$1,080,000	$412,000	$311,846	$100,154
E	$1,420,000	$582,000	$353,813	$228,187
Total	$3,976,000	$1,550,000	$1,008,800	$541,200
Sales Visit cost allocation = Sales visit cost x Number of sales visit for customer/Total sales visit
Product modification allocation = Product modification cost x Number of modification for customer/total number of modifications
Phone calls cost allocation = Phone calls cost x number of phone calls for customer/total phone calls
Email/electronic communication allocation = Communication cost x number of communication for customer/total number of communications