Activity-based costing, merchandising. Figure Four, Inc., specializes in the distribution of pharmaceutical products. Figure Four buys from pharmaceutical companies and resells to each of three different markets:

a. General supermarket chains

b. Drugstore chains

c. “Mom and Pop” single-store pharmacies Rick flair, the new controller of Figure Four, reported the following data for August 2007:

General “Mom and Pop”

Supermarket Drugstore Single Chains Chains Stores Average revenue per delivery $37,080 $12,600 $2,376 Average cost of goods sold per delivery $36,000 $12,000 $2,160 Number of deliveries 120 300 1,000 For many years, Figure Four has used gross margin percentage [(Revenue — Cost of goods sold) h- Revenue] to evaluate the relative profitability ofits different groupings of customers

(distribution outlets).

Flair recently attended a seminar on activity-based costing and decides to consider using it at Figure Four. Flair meets with all the key managers and many staffmembers. People generally agree that there are live key activity areas at Figure Four:

Activity Area Cost Driver 1. Customer purchase order processing Purchase orders by customers 2. Line item ordering Line items per purchase order 3. Store delivery Store deliveries 4. Cartons shipped to stores Cartons shipped to a store per delivery 5. Shelf-stocking at customer stores Hours ofshelf-stocking Each customer purchase order consists of one or more line items. A line item represents a single product (such as Extra-Strength Tylenol tablets). Each store delivery entails delivery of one or more cartons ofproducts to a customer. Each product is delivered in one or more separate cartons. Figure Four staffstack cartons directly onto display shelves in a store. Currently, there is no charge for this service, and not all customers use Figure Four for this activity.

The August 2007 operating costs (other than cost of goods sold) of Figure Four are

$361,296. These operating costs are assigned to the five activity areas. The costs in each area and the amount ofthe cost driver units used in that area for August 2007 are as follows:

Total Units ofCost Total Costs in Driver Used Activity' Area August 2007 in August 2007 1. Customer purchase order processing $ 96,000 2,000 orders 2. Line item ordering 76,608 21,280 line items 3. Store delivery' 85,200 1,420 store deliveries 4. Cartons shipped to stores 91,200 76,000 cartons 5. Shelf-stocking at customer stores 12,288

$361,296 640 hours Other data for August 2007 include the following:

General Supermarket Chains Drugstore Chains

“Mom and Pop Single Stores Total number of orders 140 360 1,500 Average number ofline items per order 14 12 10 Total number ofstore deliveries 120 300 1,000 Average number of cartons shipped per store delivery 300 80 16 Average number of hours of shelf-stocking per store delivery 3.0 0.6 0.1 Required 1. Compute the August 2007 gross margin percentage for each ofFigure Four’s three distribu¬
tion markets. What is the operating income of Figure Four? What are the overall gross and operating income margins from Figure Four?
2. Compute the August 2007 per unit cost driver rate for each ofthe five activity areas.
3. Compute the operating income of each distribution market in August 2007 using the activity-based costing information. Comment on the results. What new insights are avail¬
able with the activity-based information?
4. Describe four challenges Flair would face in assigning the total August 2007 operating costs of $361,296 to the five activity areas.
Excel Application For students who wish to practise their spreadsheet skills, the following is a step-by-step approach to creating an Excel spreadsheet to work this problem.
Step-by Step 1. In a new spreadsheet, create a “Financial Data” section for the financial data provided by Rick Flair, with rows for average revenue per delivery, average cost of goods sold per deliv¬
ery, and number of deliveries, and columns for “General Supermarket Chains,” “Drugstore Chains,” and “Mom and Pop Single Stores.” When you are finished, this section should look just like the table provided by Rick Flair on page 192.
2. Skip two rows. Create a “Cost-Allocation Data” section with columns labelled “Activity Area,” “Total Costs as of August 2007,” and “Total Units of Cost-Allocation Base Used in August 2007.” Next, set up a column beside the “Total Units of Cost-Allocation Base Used in August 2007” column and call the new column “Rate per Unit ofCost-Allocation Base.”
Enter the five activity area data in the next five rows.
3. Skip down two rows and create an “Activity Data” section. Set up columns for “General Supermarket Chains,” “Drugstore Chains,” and “Mom and Pop Single Stores.” Set up separate rows for each activity area. Enter the quantity of each activity used by each mar¬
ket during the period.
4. Skip two rows. Create a “Profitability Analysis” section; columns for “General Supermarket Chains,” “Drugstore Chains,” “Mom and Pop Single Stores,” and “Figure Four, Inc.”; rows for total revenues, total cost of goods sold, gross margin percentage, each ofthe five activity areas, total operating costs, operating income, and operating margin percentage.
5. In the “Profitability Analysis” section, enter calculations for total revenues, total cost of goods sold, and gross margin percentage for each market. Next calculate operating income for Figure Four, Inc., as a whole and enter this number in the operating income row of the “Figure Four, Inc.” column.
6. Go to the “Cost Allocation Data” section, enter calculations for the rate per unit ofthe costallocation base for each of the five activity areas in the “Rate per Unit of Cost-Allocation Base” column.
7. Enter calculations for the total cost of each activity in each of the different markets in your “Profitability Analysis” section.
8. Compute operating income for each market by entering the appropriate calculation in the operating income row ofthe “Profitability Analysis” section.
9. Verify the accuracy ofyourspreadsheet. Go to your “Cost-Allocation Data” section and change total order processing costs from $96,000 to $120,000. Ifyou programmed your spreadsheet correctly, operating income for Figure Four, Inc., should change to $140,304.