Customer profitability in the Agricultural and Turf division

The Board of ATC are concerned about the lack of growth in profitability of the Agriculture and Turf division. The Finance Director had asked the Management Accountant to investigate the profitability of various customers. The following information has been gathered by analysing past data and talking to the managers of the various functional departments.

The analysis of sales showing the total amount sold to large, medium and small customers is shown below.

Customer size Large Medium Small Total

Sales value $m $19,870\mathrm{.}15,677\mathrm{.}22,838\mathrm{.}528,385\mathrm{.}8$

The cost of sales is allocated based on the sales data as the costs have a direct relationship with the sale price of the products.

The majority of the research and development is undertaken based on feedback from the larger customers and the Chief Development Officer, who manages the R & D department, suggests that a sensible way to allocate the cost would be $70\%$ to the larger customers, $20\%$ to the medium customers and $10\%$ to smaller customers.

The sales, administration and general expenses can be split into the categories shown below, together with the cost driver that is considered the most appropriate for each cost category:

Expense description Costs $m Cost driver

Sales force salaries $91\mathrm{.}3$ Average number of visits: proportion large $50\%,$ medium $30\%,$ and small $20\%.$

Training of sales force $10\mathrm{.}5$

Travel and entertaining $50\mathrm{.}3$

Order processing $100\mathrm{.}1$ No of orders: proportion large $20\%,$ medium $40\%,$ and small $40\%.$

Marketing expenditure $831\mathrm{.}9$ Sales value.

Sales value

Sales value

Training of technical support staff $12\mathrm{.}6$

Discount settlements $140\mathrm{.}3$

Website maintenance $75\mathrm{.}2$ Split per marketing manager estimate $10\%$ large customers, $30\%$ medium, and $60\%$ small customers.

Distribution to customer $1004\mathrm{.}3$ Per kilometre mile: proportion large $20\%,$ medium $30\%,$ and small $50\%.$

Establishment costs associated with showroom $300\mathrm{.}5$ It is the small to medium sized customers that frequent the showrooms $$ large customers tend to be acquired via direct contacts and visits by sales staff. Estimated split: large customers $0\%,$ medium $40\%,$ small $60\%.$

Costs of specific inventory held $75\mathrm{.}3$ Allocated to large customers only, as medium to small customers tend to purchase standard equipment.

Allowance for bad debts $128\mathrm{.}1$ These are more likely with medium and smaller customers $$ marketing manager estimates $10\%$ large customers, $50\%$ medium, and $40\%$ small customers.

Amount of costs that are to remain unallocated such as general office costs, and building depreciation. $193\mathrm{.}2$ Unallocated to customers $$ to remain as general overhead costs.

The other operation costs shown in the Income Statements cannot meaningfully be attributed to specific customer groupings.

ATC Inc Financial Statements

All figures in $ millions

Consolidated income statement

$20182019202020212022$

Sales and Revenues $26,369\mathrm{.}221,270\mathrm{.}324,179\mathrm{.}330,089\mathrm{.}934,175\mathrm{.}8$

Finance and interest income $2,068\mathrm{.}41,842\mathrm{.}11,825\mathrm{.}31,922\mathrm{.}61,981\mathrm{.}3$

Total income $28,437\mathrm{.}623,112\mathrm{.}426,004\mathrm{.}632,012\mathrm{.}536,157\mathrm{.}1$

Cost of sales $19,574\mathrm{.}816,255\mathrm{.}217,398\mathrm{.}821,919\mathrm{.}425,007\mathrm{.}8$

Gross margin $8,862\mathrm{.}86,857\mathrm{.}28,605\mathrm{.}810,093\mathrm{.}111,149\mathrm{.}3$

Research and development expenses $943\mathrm{.}1977\mathrm{.}01,052\mathrm{.}41,226\mathrm{.}21,433\mathrm{.}6$

Selling, administration and general expenses $2,960\mathrm{.}22,780\mathrm{.}62,968\mathrm{.}73,168\mathrm{.}73,417\mathrm{.}0$

Other operating expenses $697\mathrm{.}8718\mathrm{.}0748\mathrm{.}1716\mathrm{.}0781\mathrm{.}5$

Operating profit $4,261\mathrm{.}72,381\mathrm{.}63,836\mathrm{.}64,982\mathrm{.}25,517\mathrm{.}2$

Interest charges $1,137\mathrm{.}01,042\mathrm{.}4811\mathrm{.}4759\mathrm{.}4782\mathrm{.}8$

Profit before taxation $3,124\mathrm{.}71,339\mathrm{.}23,025\mathrm{.}24,222\mathrm{.}84,734\mathrm{.}4$

Taxation $1,111\mathrm{.}2460\mathrm{.}01,161\mathrm{.}61,423\mathrm{.}61,659\mathrm{.}4$

Profit for the year $2,013\mathrm{.}5879\mathrm{.}21,863\mathrm{.}62,799\mathrm{.}23,075\mathrm{.}0$

$($a$)$ Utilising the information provided by the management accountant relating to customer profitability analysis:

$($i$).$ Produce an analysis of the relative customer segment profitability for the Agriculture and Turf division;

$($ii$).$ Critically evaluate the analysis and discuss any observations or concerns that you have about the accuracy of the analysis you have been able to undertake and the way the costs have been allocated to customers, or whether you consider that certain cost categories should not be included in the analysis. Where appropriate, suggest an alternative basis for allocating costs to customers;

$($iii$).$ Briefly discuss whether you feel that the customer segment analysis undertaken is appropriate or whether alternative forms of customer profitability analysis are appropriate and why.