BACKGROUND

Cynthia's Cycles Ltd. (CC) imports lightweight touring bikes into New Zealand and currently sells them to three independent cycle wholesalers. CC does not currently sell to retail stores or direct to the general public. The managing director and owner, Cynthia Cog, believes that the company has seen off the worst of the recession, but is conscious that there is too much spare capacity and she must make efforts to expand the company's customer base. Cynthia is concerned about current profitability levels. CC is such a small company that it has no control over the price it pays to its bike suppliers. So to improve profitability CC needs to concentrate on improving the efficiency of CC's sales and distribution. Cynthia is convinced that 'buying' market share with excessive discounts does not work and she is concerned that during the recession, the level of discounts that were offered in order to keep some customers 'loyal' were excessive.

DETAIL Cynthia asks her management accountant, Simon Spoke, to review last year's financial statements and to produce a rudimentary customer profitability analysis (CPA). Simon is still a provisional chartered accountant (CA) who is studying for his CA exams and is not entirely sure what Cynthia wants, but he uses his rudimentary knowledge of activity-based costing (ABC) methodology to produce the CPA shown in table 1. Cynthia arranges a meeting with CC's sales and marketing director, Polly Peddler, in order to discuss the new CPA statement. She is not terribly happy and starts firing questions at Polly: "We threw a party last year when you won the Wise Wheels account, but the CPA shows that the account made a $37,500 operating loss last year. Are they getting excessive discounts?"

Table 2 - Cost drivers and burden rates: Activity Driver Burden costs ($) Cost Drivers quantity rates ($) Account management 76,000 Number of Customer Orders 95 800 Sales and marketing 81,000 Number of Sales Visits 54 1500 Packing and loading 48,000 Number of Deliveries 96 500 Transport to customer 48,000 Delivery Kilometres 4800 10 253,000 Table 3 - Cost driver data for last accounting year: Totals Cycles R Us Bikes 2U Wise Wheels Number of Customer Orders 95 24 24 47 Number of Sales Visits 54 12 18 24 Number of Deliveries 96 48 24 24 Delivery Kilometres 4,800 960 1,440 2,400Table 1 - Customer Profitability Analysis: Total Cycles R Us Bikes 2U Wise Wheels $ $ EA $ Revenues (list price) 2,835,000 1,995,000 504,000 336,000 Gross Profit 568,680 399,000 85,680 84,000 Gross margin 20.1% 20.0% 17.0% 25.0% Less Selling and Distribution costs: Account management 76,000 19,200 19,200 37,600 Sales and marketing 81,000 18,000 27,000 36,000 Packing and loading 48,000 24,000 12,000 12,000 Transport to customer 48,000 9,600 14,400 24,000 Total S&D costs 253,000 70,800 72,600 109,600 Customer Contribution 315,680 328,200 13,080 -25,600 Corporate sustaining costs 100,000 70,370 17,778 11,852 Net operating profit/(loss) 215,680 257,830 -4,698 -37,452 Operating Profit Margin 7.6% 12.9% -0.9% -11.1%