Activity Based Costing:
The New Century Linen Company is a small family company that produces and sells towels. Century sells the towels to three types of stores: department stores, mid-sized specialty stores and small gift shops. The company is doing well and the CEO wants to expand the business. The contribution margin ratio is the highest for the small gift shops, so the CEO feels that those are the type of retail outlets to pursue.
Below find Century's income statement for last year.
Century Linen Company
For the year ended 12-31-XX
|
Sales
|
|
$500,000
|
|
Variable Production Costs
|
|
150,000
|
|
Contribution Margin
|
|
$350,000
|
|
Fixed Costs:
|
|
|
|
Production Overhead
|
$120,000
|
|
|
Selling & Distribution Costs
|
180,000
|
300,000
|
|
Net Operating Income
|
|
$50,000
|
|
|
|
======
|
Customer support & distribution costs are pretty high at Century. The total amount was $180,000 last year. The marketing manager has recently been to a seminar and learned about applying ABC to analyze customer and distribution costs. He suggests that the company analyze overhead costs associated with supporting different types of customers before proceeding with an expansion. The marketing manager knows that the small shops require a lot of attention and is somewhat dubious about the CEO's proposed strategy. The CEO accepts the suggestion and you are brought in as a consultant to prepare the analysis. The table below provides some information that may be pertinent for the analysis.
|
Description
|
Customer Support & Distribution Costs
|
Department Stores
Activity Level
|
Specialty Shops
Activity Level
|
Gift Shops
Activity Level
|
|
Sales (units)
|
|
10,000
|
5,000
|
5,000
|
|
Revenues
|
|
$150,000
|
$100,000
|
$250,000
|
|
Contribution margin ratio
|
|
50%
|
75%
|
80%
|
|
No of customers
|
|
5
|
45
|
250
|
|
Total costs/No of orders places
|
$40,000
|
10
|
90
|
900
|
|
Total costs/No of sales calls
|
80,000
|
5
|
195
|
800
|
|
Total costs/No of shipments
|
60,000
|
20
|
480
|
1,000
|
Required:
1. Calculate the customer support and distribution costs associated with the three types of customers.
o Use a simple strategy first and allocate the costs based on revenues.
o Recalculate the allocations using activity based costing (ABC).
2. Determine contribution margin less customer support and distribution costs for both approaches above.
3. Which type of customer should the company support and why? Refer to your analysis in your response.