Question

EXERCISE 7-10 Customer Profitability Analysis [LO7-3, L07-4, L07-5] Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 5%. For example, if a hospital buys supplies from Worley that had cost Worley $100 to buy from manufacturers, Worley would charge the hospital $105 to purchase these supplies. For years, Worley believed that the 5% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits Worley decided to implement an activity-based costing system to help improve its understanding of cus- tomer profitability. The company broke its selling and administrative expenses into five activities as shown below: Activity Cost Pool (Activity Measure) Total Cost Total Activity $ 500,000 248,000 5,000 deliveries 4,000 orders Customer deliveries (Number of deliveries) .......... Manual order processing (Number of manual orders)... Electronic order processing (Number of electronic orders) .................... Line item picking (Number of line items picked) ...... Other organization-sustaining costs (None) ... Total selling and administrative expenses ..... 12,500 orders 450,000 line items 200,000 450,000 602,000 $2,000,000 Worley gathered the data below for two of the many hospitals that it serves-University and Memorial (both hospitals purchased a total quantity of medical supplies that had cost Worley $30,000 to buy from its manufacturers): Activity University Memorial 10 25 Activity Measure Number of deliveries ........ Number of manual orders ...... Number of electronic orders .. Number of line items picked .... 0 15 120 250 Required: 1. Compute the total revenue that Worley would receive from University and Memorial. 2. Compute the activity rate for each activity cost pool. 3. Compute the total activity costs that would be assigned to University and Memorial. 4. Compute Worley's customer margin for University and Memorial. (Hint: Do not overlook the $30,000 cost of goods sold that Worley incurred serving each hospital.) 5. Describe the purchasing behaviors that are likely to characterize Worley's least profitable customers.