Activity-based costing for a service company Wells Fargo Insurance Services (WFIS) is an insurance brokerage company that classified insurance products as either “easy” or “difficult.” Easy and difficult products were defined as follows:

Easy: Electronic claims, few inquiries, mature product Difficult: Paper claims, complex claims to process, many inquiries, a new product with complex options The company originally allocated processing and service expenses on the basis of revenue. Under this traditional allocation approach, the product profitability report revealed the following:

Easy Difficult Product Product Total Revenue $600 $400 $1,000 Processing and service expenses 420 280 700 ____ ____ _____ Income from operations $180 ____ $120 ____ $_____ 300 ____ ____ _____ Operating income margin 30% 30% 30%

WFIS decided to use activity-based costing to allocate the processing and service expenses. The following activity-based costing analysis of the same data illustrates a much different profit picture for the two types of products:

Easy Difficult Product Product Total Revenue $600 $ 400 $1,000 Processing and service expenses 183 517 700 ____ ____ _____ Income from operations $417 $(117) $ 300 ____ ____ ____ ____ _____ _____ Operating income margin 70% (29%) 30%

Explain why the activity-based profitability report reveals different information from the traditional sales allocation report.

Source: Dan Patras and Kevin Clancy, “ABC in the Service Industry: Product Line Profitability at Acordia, Inc.” As Easy as ABC Newsletter, Issue 12, Spring 1993.