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Traditional Costing/Activity Based Costing

Capacity costs

K's Cornerspot, a popular university eatery in a competitive market, has seating & staff capacity to serve about 600 lunch customers every day. For the past 2 months, demand has fallen from its previous near-capacity level. Concerned about his declining profit, K decided to take a closer look at its costs. He concluded that food was the primary cost that varied with meals served; the remaining costs of $3300 per day were fixed. With demand averaging 550 lunches per day for the past 2 months, K thought it was reasonable to divide the $3300 fixed costs by the current average demand of 550 lunches to arrive at an estimate of $6 of support costs per meal served. Noting that his support costs per meal had now increased, he contemplated raising his meal prices.

A. What is likely to happen if K continues to recompute his costs using the same approach if demand decreases further?
B. Advise K on choosing a cost driver quantity for computing support costs per meal & explain why you advocate your choice of quantity.

Assigning marketing, distribution, & selling expenses to customers

T Company's cost system assigns marketing, distribution, & selling expenses to customers using a rate of 33% of sales revenue. The new controller has discovered that T's customers differ greatly in their ordering patterns & interaction with T's sales force. Because the controller believes T's cost system does not accurately assign marketing, distribution & selling expenses to customers, she developed an activity-based costing system to assign these expenses to customers. She then identified the following marketing, distribution, & selling costs for two customers, Ashton & Brown:

Ashton Brown
Sales representative travel $9,000 $42,000
Service customers 15,000 110,000
Handle customer orders 1,000 12,000
Ship to customers 24,000 72,000

The following additional information is available:

Ashton Brown
Sales $430,000 $350,000
Cost of goods sold 220,000 155,000

A. Using the current cost system's approach of assigning marketing, distribution & selling expenses to customers using a rate of 33% of sales revenue, determine the operating profit associated with Ashton & with Brown.
B. Using the activity-based costing information provided, determine the operating profit associated with Ashton & with Brown.
C. Which of the two methods produces more accurate assignments of marketing, distribution & selling expenses to customers? Explain.

Solution Summary

The solution explains cost assignment using traditional costing and activity based costing

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