Activity-Based Costing for a Service Company

Bounce Back Insurance Company carries three major lines of insurance: auto, workers' compensation, and homeowners. The company has prepared the following report:

Bounce Back Insurance Company Product Profitability Report For the Year Ended December 31
	Auto		Workers' Compensation		Homeowners
Premium revenue	$5,800,000		$6,250,000		$8,200,000
Estimated claims	(4,060,000)	(4,375,000)	(5,740,000)
Underwriting income	$1,740,000	$1,875,000	$2,460,000
Underwriting income as a percent of premium revenue	30%	30%	30%

Management is concerned that the administrative expenses may make some of the insurance lines unprofitable. However, the administrative expenses have not been allocated to the insurance lines. The controller has suggested that the administrative expenses could be assigned to the insurance lines using activity-based costing. The administrative expenses are comprised of five activities. The activities and their rates are as follows:

Activity	Activity Rates
New policy processing	$110 per new policy
Cancellation processing	$180 per cancellation
Claim audits	$330 per claim audit
Claim disbursements processing	$100 per disbursement
Premium collection processing	$25 per premium collected

Activity-base usage data for each line of insurance were retrieved from the corporate records as follows:

	Auto		Workers' Compensation		Homeowners
Number of new policies		1,330		1,400				4,100
Number of canceled policies		490		300				2,200
Number of audited claims		390		110				950
Number of claim disbursements		470		220				850
Number of premiums collected		8,500		1,900				15,200

Question Content Area

a. Complete the product profitability report through the administrative activities. Determine the operating income as a percent of premium revenue. Rounded to the nearest whole percent.

	Auto	Workers' Comp.	Homeowners
Premium revenue	$fill in the blank d0ba12070f8bfcb_1	$fill in the blank d0ba12070f8bfcb_2	$fill in the blank d0ba12070f8bfcb_3
Estimated claims	fill in the blank d0ba12070f8bfcb_4	fill in the blank d0ba12070f8bfcb_5	fill in the blank d0ba12070f8bfcb_6
Underwriting income	$fill in the blank d0ba12070f8bfcb_7	$fill in the blank d0ba12070f8bfcb_8	$fill in the blank d0ba12070f8bfcb_9
Administrative activities:
New policy processing	$fill in the blank d0ba12070f8bfcb_10	$fill in the blank d0ba12070f8bfcb_11	$fill in the blank d0ba12070f8bfcb_12
Cancellation processing	fill in the blank d0ba12070f8bfcb_13	fill in the blank d0ba12070f8bfcb_14	fill in the blank d0ba12070f8bfcb_15
Claim audits	fill in the blank d0ba12070f8bfcb_16	fill in the blank d0ba12070f8bfcb_17	fill in the blank d0ba12070f8bfcb_18
Claim disbursements processing	fill in the blank d0ba12070f8bfcb_19	fill in the blank d0ba12070f8bfcb_20	fill in the blank d0ba12070f8bfcb_21
Premium collection processing	fill in the blank d0ba12070f8bfcb_22	fill in the blank d0ba12070f8bfcb_23	fill in the blank d0ba12070f8bfcb_24
Total administrative expenses	$fill in the blank d0ba12070f8bfcb_25	$fill in the blank d0ba12070f8bfcb_26	$fill in the blank d0ba12070f8bfcb_27
Operating income	$fill in the blank d0ba12070f8bfcb_28	$fill in the blank d0ba12070f8bfcb_29	$fill in the blank d0ba12070f8bfcb_30
Operating income as a percent of premium revenue	fill in the blank d0ba12070f8bfcb_31%	fill in the blank d0ba12070f8bfcb_32%	fill in the blank d0ba12070f8bfcb_33%

Question Content Area

b. Interpret the report.

All three insurance lines have

differentthe same

percentage of underwriting income to premium revenue. The differences among the insurance lines are in the way they consume

administrativeclaims

activities. The

HomeownersWorkers' CompensationAuto

insurance line has the

leasthighest

profitability because it has

smallerlarger

and

moreless

frequent claims that require more auditing and disbursement processing than do the other two lines. In addition, the Homeowners line has a much higher rate of cancellation relative to the other two lines (over 50% of new policies). Lastly, the Homeowners line has more premium collections compared to the other two lines. Possibly, the Homeowners line is collected in smaller amounts from more customers than the other two lines. In contrast, the

HomeownersWorkers' CompensationAuto

line consumes the

mostfewest

administrative activities, causing it to be very profitable. The Auto line is in between these two.