After 10 years of working as an internal auditor at a large insurance company, Malvika decided to realize her dream of running her own business. She had a young family and wanted the flexibility in hours that a small business would provide. Her job at the insurance company gave her the chance to travel to Costa Rica, where she developed a love of fine coffee. After years of dreaming, planning, and saving, she started Coffee Lovers Subscription Box in January 2020. While he expected business to be slow at first, she was disappointed in the financial results in her first year of operations. (See Exhibit 1)

Coffee Lovers is an online company that provides a premium coffee delivery service to its members. For $20/month, members receive a package containing four different packs of coffee, which is carefully selected by Malvika through her contacts in Costa Rica. Each month the coffee changes, allowing Malvika to fulfill her goals of bringing a variety of premium Costa Rican coffee to the Canadian market as well as supporting many of the small coffee producers she got to know in her travels to Costa Rica.

Malvika did her research before deciding to open Coffee Lovers. Coffee is one of the most popular drinks in the world and consumption of coffee in Canada is increasing. Malvika felt that busy Canadians would appreciate the convenience of having premium coffee delivered to their door and that the $20 monthly fee would be enough to cover her costs plus give her some income to support her family.

The business model Malvika set up is simple. Members subscribe to the service on the Coffee Lovers website. After completing a form with name, address, and credit card information, members start receiving their monthly boxes of coffee. Recognizing that members may need to suspend deliveries for vacations or other reasons, the website has a spot where members can pause and restart their accounts at any time. Members can also access a discussion board where they can leave comments about their favourite blends of coffee. The coffee is pre-ordered from Costa Rica and packaged in Coffee Lovers’ office space, which Malvika rents from her aunt at a reasonable rate.

Demand was strong enough in the first year that Malvika needed to hire four part-time staff to help her run the company. One staff member is responsible for the website and the member accounts. The other three, package the coffee and send it to members. Being close to a large university, Malvika easily filled the four part-time positions with students hoping to earn some extra money. Because of Malvika’s experience in Costa Rica, she has kept control of selecting and ordering the coffee from Costa Rican suppliers. With her background in internal audit, Malvika keeps tight control of the company operations.

Despite all of Malvika’s hard work, she is worried about whether her business will be able to generate enough profit to support her family. She knows that competition is tough, with premium coffee shops in many convenient locations. If she could increase the number of members, she believes Coffee Lovers could become profitable. She remembers learning about activity based costing in university and wants to see if it could be used to help her company. She figured she would talk to her staff to see if they could provide any insight on the various activities of the business. The information they provided is in Exhibit II. If Coffee Lovers did not start to generate profits, she might have to go back to work at the insurance company. She was very well respected when she resigned, and her boss did say to contact him in the future if she ever needed work.

Required:

1. Using a case format, prepare a report to Malvika highlighting the issues facing Coffee Lovers.

2. Using the information from Exhibit II, develop an Income Statement based on activity based costing information

   3. Include recommendations as to what Malvika should do to turn a profit
     

Exhibit I- Coffee Lovers Subscription Box Financials Coffee Lovers Subscription Box Income Statement Year Ended December 31, 2020 Sales ($20/boxx 324 boxes per month) Cost of Goods Sold ($8/box x 324 boxes per month) Gross Margin $77,760 $31,104 $46,656 Selling & administrative expenses Shipping Marketing (website maintenance and advertising) 14,720 2,500 Rent 15,000 General and administrative 31,000 Total selling and administrative expenses 63,220 Operating Income ($16,564) Note: cost of goods sold includes only the cost of the coffee. All fixed overhead costs are included in selling and administrative expenses.