Activity Based Costing
The New Millennium (Millenium) Linen Company is a small family company that produces and sells towels. Millennium 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.
ATTACHED you'll find Millennium's income statement for last year.
Customer support & distribution costs are pretty high at Millennium. 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 ATTACHED DOCUMENT provides some information that may be pertinent for the analysis.
Calculate the customer support and distribution costs associated with the three types of customers.
Use a simple strategy first and allocate the costs based on revenues.
Recalculate the allocations using activity based costing (ABC).
Determine contribution margin less customer support and distribution costs for both approaches above.
Which type of customer should the company support and why? Refer to your analysis in your response.
Description Customer Support & Distribution Costs Department Stores
Activity Level Specialty Shops
Activity Level Gift Shops
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
Your response is 811 words including two reports in Excel. Click on cells to see computations. The draft report shows ...
Your response is 811 words including two reports in Excel. Click on cells to see computations. The draft report shows operating profit for each unit under a simple allocation method and then activity based costing. The discussion indicates why gift shops look like the best expansion opportunity under one allocation method but the worst under another. The comments reveal another potential ways to use ABC to improve profits without rejecting the "lower profit per customer" segments.