After 10 years of working as an internal auditor at a large insurance company, Patrick Vickers decided to realize his dream of running his own business.He had a young family and wanted the flexibility in hours that a small business would provide.His job at the insurance company gave him the chance to travel to Asia, where he developed a love of fine tea.After years of dreaming, planning, and saving, he started TeaTime.com in January 2012.While he expected business to be slow at first, he was disappointed in the financial results in his first year of operations.(See Exhibit 1.)TeaTime.com is an online company that provides a premium tea delivery service to its members.For $20 per month, members receive a package containing four different blends ofloose-leaf tea, which is care fully selected by Patrick through his contacts in Asia.Each month the blends of tea changes, allowing Patrick to fulfill his goals of bringing a variety of premium Asian tea to the Canadian market as well as supporting many of the small tea producers he got to know in his travels to AsiaPatrick did his research before deciding to open TeaTime.com.Tea is one of the most popular drinks in the world and consumption of tea in Canada is increasing as consumers are becoming more aware of its health benefits.Patrick felt that busy Canadians would appreciate the convenience of having premium tea delivered to their door and that the $20 monthly fee would be enough to cover his costs plus give him some income to support his familyThe business model Patrick set up is simple.Members subscribe to the service on the TeaTime.com website.After completing a form with name, address, and credit card information, members start receiving their monthly boxes of tea.Recognizing that members mav 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 tea.The tea is pre-ordered from Asia and packaged in TeaTime.com's office space, which Patrick rents from his unde at a reasonable rate.Demand was strong enough in the first year that Patrick needed to hire four part-time staff to help him run the company.One staff member is responsible for the website and the member accounts.The other three package the tea and send it to members.Being close to a large university, Patrick easily filled the four part-time positions with students hoping to earn some extra money.Because of Patrick's experience in Asia, he has kept control of selecting and ordering the tea from the Asian suppliers.With his background in internal audit, Patrick keeps tight control of the company operations despite all of Patrick's hard work, he is worried about whether his business will be able to generate enough profit to support his family.He knows that competition is tough, with premium tea shops in many convenient locations.If he could increase the number of members, he believes TeaTime.com could become profitable.He remembers learning about activity-based costing in university and wants to see if it could be used to help his company.He figured he would talk to his staff to see if they could provide any insight on the various activities of the business.(The information they provided is in Exhibit 2.)If TeaTime.com did not start to generate profits, he might have to go back to work at the insurance company.He was very well respected when he resigned, and his boss did say to contact him in the future if he ever needed work.

Required 1. Using a case format, prepare a report to Patrick highlighting the issues facing Tea Time.com. 2. Using the information from Exhibit 2, develop an Income Statement based on activity-based costing information. 3. Include recommendations as to what Patrick should do to turn a profit. Chapter 5: Activity-Based Costing 19 EXHIBIT 1 - TEATIME.COM FINANCIALS TEATIME.COM Income Statement Year Ended December 31, 2012 Sales ($20/box x 324 boxes per month) $ 77,760 Cost of goods sold ($8/box x 324 boxes per month) 31,104 Gross margin 46,656 Selling and administrative expenses Shipping 14,720 Marketing (website maintenance and advertising) 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 tea. All fixed overhead costs are included in selling and administrative expenses. EXHIBIT 2 - INFORMATION FROM STAFF ABOUT THE OPERATIONS OF TEATIME.COM After talking with his staff about TeaTime.com's selling and administrative expenses, Patrick decides to gather activity-based costing information for the shipping and general and administrative expenses and cre- ates four activity cost pools. Shipping expenses are put in a "Package and ship tea" activity, and general and administrative expenses are split into three activities: "Set up member accounts," "Process pause and restart requests," and "Support members." The following information was gathered from discussions with his staff about these activities for their first year of operations. Cost drivers were selected by Patrick and activity rates were determined through discussions with Patrick and his staff by estimating the percentage of time they spend on each activity. Activity Cost Pool Cost Driver Total Quantity of Cost Driver Activity Rate Package and ship tea Number of boxes shipped 3,888 $3.786 per box Set up member accounts Number of new members 150 $5 per member Process pause and restart Number of pause and 600 $49.584 per request requests restart requests Support members Number of members 150 $3.333 per member