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 Estimated claims $5,800,000 (4,060,000) $1,740,000 $6,250,000 (4,375,000) $1,875,000 $8,200,000 (5,740,000) $2,460,000 Underwriting income 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 New policy processing Cancellation processing Activity Rates $110 per new policy $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 Homeowners Workers' Compensation 1,400 1,330 Number of new policies Number of canceled policies Number of audited claims 4,100 2,200 490 300 390 110 950 Number of claim disbursements 470 220 850 Number of premiums collected 8,500 1,900 15,200 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. Bounce Back Insurance Company Product Profitability Report For the Year Ended December 31 Auto Workers' Comp. Homeowners Premium revenue Estimated claims Underwriting income Administrative activities: $ New policy processing Cancellation processing Claim audits Claim disbursements processing Premium collection processing Total administrative expenses $ Operating income $ % % % Operating income as a percent of premium revenue b. Interpret the report. All three insurance lines have percentage of underwriting income to premium revenue. The differences among the insurance lines are in the way they consume activities. The insurance line has the profitability because it has and 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 line consumes the administrative activities, causing it to be very profitable. The Auto line is in between these two
