Work Depot sells office supplies to area corporations and organizations. Tom Dooley, founder and CEO, has been disappointed with the operating results and the profit margin for the last two years. Business forms are mostly a "commodity" business with low profit margins. To increase profit margins and gain competitive advantages, Dooley introduced "Desk-Top Delivery" service (smaller orders, same-day delivery). The business seems to be as busy as ever. Yet, the operating income has been declining. To help identify the root cause of declining profits, he decided to analyze the profitability of two of the firm's major customers: Gamma International (Gamma) and City of Albany (Albany). Based on the customer profitability analysis that Work Depot conducts regularly, both Gamma and Albany have the same amount of total sales. However, the firm earns a higher gross margin and gross margin ratio from Albany than those from the sales to Gamma, as shown in Table 1 of the accompanying Excel file. Work Depot adds a flat 17.5% fee to all sales for expenses incurred in such activities as handling customers' requests, pick-packing, order delivery, warehousing, and data entry. However, not all customers require the same level of services. Operation Manager, Jamie Steel, points out that Albany has been a much heavier service user than Gamma. Table 2 of the accompanying Excel file shows data to support her belief. Steel points out that activities cost money. Two customers who request different service activities most likely are not costing the firm the same. Tom requested the Controller to investigate ways to determine the costs of performing various activities. His summarized findings are presented in Table 3 of the accompanying Excel file. REQUIRED: a. On your Excel file, present the activity-based costing (ABC), computing the charges per unit of service activities and total distribution costs for each of the customers. (Part of the grade is based on the clarity of your steps and presentation of the information. b. What are the Customer Profitability measures for Gamma and Albany under ABC? c. Consider the different types of customers that Gamma and Albany represent, the product that Work Depot sells, and the new Desk-Top Service it provides. How might Work Depot reconsider its current pricing strategy of adding the flat 17.5% fee to all customers? 4 5 TABLE 1 6 7 8 Customer Profitability Analysis Gamma Albany $ 80,000 $ 80,000 $ (50,000) $ (48,000) $ (14,000) $ (14,000) 23 TABLE 3 Total Estimated Costs 24 Activity 25 26 27 28 29 Requisitions handling Warehouse Pick-packing Data entry Delivery This is all the data given

4 5 TABLE 1 6 7 8 Customer Profitability Analysis Gamma Albany $ 80,000 $ 80,000 $ (50,000) $ (48,000) $ (14,000) $ (14,000) $ 16,000 $ 18,000 20.0% 22.5% Sales Product cost Service fees (17.5% of sales) Gross margin Gross margin percent 9 10 11 12 13 14 15 16 17 18 TABLE 2 Distribution Services Activities for Gamma and Albany Gamma Number of requisitions 300 Average number of cartons in warehouse 50 Requisition line (all pick-packing) 900 Number of miles per delivery 5 19 Albany 700 500 2,100 6 20 21 22 23 TABLE 3 Total Estimated Costs 24 Activity 25 26 27 28 29 Requisitions handling Warehouse Pick-packing Data entry Delivery charge Estimated Annual Activity Annual Activity Cost Driver Expense Level $3,000,000 Requisitions 300,000 $1,050,000 Number of cartons 70,000 $900,000 Pick-pack lines 600,000 $600,000 Pick-pack lines 600,000 $10 per requisition (delivery) plus $0.30 per mile 30 4 5 TABLE 1 6 7 8 Customer Profitability Analysis Gamma Albany $ 80,000 $ 80,000 $ (50,000) $ (48,000) $ (14,000) $ (14,000) $ 16,000 $ 18,000 20.0% 22.5% Sales Product cost Service fees (17.5% of sales) Gross margin Gross margin percent 9 10 11 12 13 14 15 16 17 18 TABLE 2 Distribution Services Activities for Gamma and Albany Gamma Number of requisitions 300 Average number of cartons in warehouse 50 Requisition line (all pick-packing) 900 Number of miles per delivery 5 19 Albany 700 500 2,100 6 20 21 22 23 TABLE 3 Total Estimated Costs 24 Activity 25 26 27 28 29 Requisitions handling Warehouse Pick-packing Data entry Delivery charge Estimated Annual Activity Annual Activity Cost Driver Expense Level $3,000,000 Requisitions 300,000 $1,050,000 Number of cartons 70,000 $900,000 Pick-pack lines 600,000 $600,000 Pick-pack lines 600,000 $10 per requisition (delivery) plus $0.30 per mile 30