Question

14-21 Customer profitability, distribution. Best Drugs is a distributor of pharmaceutical products. Its ABC system has five activities: Activity Area Cost Driver Rate in 2017 Order processing $42 per order Line-item ordering $5 per line item Store deliveries $47 per store delivery Carton deliveries $4 per carton Shelf-stocking $13 per stocking-hour Rick Flair, the controller of Best Drugs, wants to use this ABC system to examine individual customer profitability within each distribution market. He focuses first on the Ma and Pa single-store distribution market. Using only two customers helps highlight the insights available with the ABC approach. Data pertaining to these two customers in August 2017 are as follows: Table shows the data of Best Drugs pertaining to two of its customers for August 2017. Details of the two customers area as follows: (A) Ann Arbor Company • Total orders: 13 • Average line items per order: 11 • Total store deliveries: 5 • Average cartons shipped per store delivery: 21 • Average hours of shelf-stocking per store delivery: 0.5 • Average revenue per delivery: $2,600 • Average cost of goods sold per delivery: $2,100 (B) San Diego Pharmacy • Total orders: 7 • Average line items per order: 19 • Total store deliveries: 7 • Average cartons shipped per store delivery: 18 • Average hours of shelf-stocking per store delivery: 0.75 • Average revenue per delivery: $1,900 • Average cost of goods sold per delivery: $1,700 Ann Arbor Pharmacy San Diego Pharmacy Total orders 13 7 Average line items per order 11 19 Total store deliveries 5 7 Average cartons shipped per store delivery 21 18 Average hours of shelf-stocking per store delivery 0.5 0.75 Average revenue per delivery $2,600 $1,900 Average cost of goods sold per delivery $2,100 $1,700 Required Use the ABC information to compute the operating income of each customer in August 2017. Comment on the results and what, if anything, Flair should do. Flair ranks the individual customers in the Ma and Pa single-store distribution market on the basis of monthly operating income. The cumulative operating income of the top 20% of customers is $58,120. Best Drugs reports operating losses of $23,670 for the bottom 40% of its customers. Make four recommendations that you think Best Drugs should consider in light of this new customer-profitability information.

Answer 1

Ann Arbor Company has an operating income of -$448.50 and San Diego Pharmacy has an operating income of -$1,260.25. Both customers are operating at a loss in August 2017.

Step-by-step explanation:

To compute the operating income of each customer in August 2017, we need to calculate the cost for each activity for both Ann Arbor Company and San Diego Pharmacy.

For Ann Arbor Company:

• Order processing cost: 13 orders * $42 per order = $546
• Line-item ordering cost: 13 orders * 11 line items * $5 per line item = $715
• Store deliveries cost: 5 store deliveries * $47 per store delivery = $235
• Carton deliveries cost: 5 store deliveries * 21 cartons per store delivery * $4 per carton = $420
• Shelf-stocking cost: 5 store deliveries * 0.5 hours of shelf-stocking per store delivery * $13 per stocking-hour = $32.50

For San Diego Pharmacy:

• Order processing cost: 7 orders * $42 per order = $294
• Line-item ordering cost: 7 orders * 19 line items * $5 per line item = $665
• Store deliveries cost: 7 store deliveries * $47 per store delivery = $329
• Carton deliveries cost: 7 store deliveries * 18 cartons per store delivery * $4 per carton = $504
• Shelf-stocking cost: 7 store deliveries * 0.75 hours of shelf-stocking per store delivery * $13 per stocking-hour = $68.25

Now we can calculate the operating income for each customer:

For Ann Arbor Company:

• Operating income = Average revenue per delivery - Average cost of goods sold per delivery - Order processing cost - Line-item ordering cost - Store deliveries cost - Carton deliveries cost - Shelf-stocking cost
• Operating income = ($2,600 - $2,100) - $546 - $715 - $235 - $420 - $32.50
• Operating income = $500 - $546 - $715 - $235 - $420 - $32.50
• Operating income = -$448.50

For San Diego Pharmacy:

• Operating income = Average revenue per delivery - Average cost of goods sold per delivery - Order processing cost - Line-item ordering cost - Store deliveries cost - Carton deliveries cost - Shelf-stocking cost
• Operating income = ($1,900 - $1,700) - $294 - $665 - $329 - $504 - $68.25
• Operating income = $200 - $294 - $665 - $329 - $504 - $68.25
• Operating income = -$1,260.25

Based on the calculations, Ann Arbor Company has an operating income of -$448.50 and San Diego Pharmacy has an operating income of -$1,260.25. Both customers are operating at a loss in August 2017.