Running Head: Johnson Beverages

Finance Assignment
Name of the Writer
Name of the Institute
Date
Running Head: Johnson Beverages

Introduction

Cost allocation of indirect cost

Activity-based costing ABC is a costing methodology that identifies activities in an

organization and assigns the cost of each activity with resources to all products according to

the actual consumption by each. This model assigns more indirect costs, overhead into direct

costs compared to traditional costing.

Weakness of tradition cost allocation is often based on volume such as number of products

manufactured, number of direct labor hours, number of production machine hours, number of

square feet, etc. Unfortunately, it is becoming more frequent that the common costs

or indirect costs that require allocation are not caused by volume. In other words, traditional

cost allocations are often based on something other than the root causes of the costs.

It is possible that a significant amount of manufacturing overhead might not be caused by

production machine hours or by the customer in this case Saver Super store, yet the overhead

is allocated using those hours. For example, a few of a manufacturer's low volume products

may require significant amounts of engineering changes, additional inspections, frequent

machine setups with unusually short production runs, special handling, additional storage,

and so on. To allocate these special costs to all products on the basis of the number of

production machine hours (instead of allocating those costs based on their root causes) will

result in individual product costs that are inaccurate and misleading.

Methodology of ABC focuses on indirect cost allocation in operational management. ABC

helps to segregate, fixed cost, Variable cost, Overhead cost, the split of cost helps to

identify cost drivers, if achieved. Direct labor and materials are relatively easy to trace

directly to products, but it is more difficult to directly allocate indirect costs to products.
Running Head: Johnson Beverages

Where products use common resources differently, some sort of weighting is needed in the

cost allocation process. The cost driver is a factor that creates or drives the cost of the

activity. For example, the cost of the activity of bank tellers can be ascribed to each product

by measuring how long each product's transaction (cost driver) takes at the counter and then

by measuring the number of each type of transaction.

Greater costing accuracy is the primary benefit of activity-based costing. Companies assign

cost only to the products that require the activity for production. ABC method eliminates

allocating irrelevant costs of a product and customer. Other advantages of activity-based

costing include an easy interpretation of cost for internal management, the ability to enable

benchmarking and a greater understanding of overhead costs. Implementing an activity-based

costing system within a company requires substantial resources. This can prove a

disadvantage for companies with limited funds.

Running Head: Johnson Beverages

Assess the cost drivers

 A cost driver is the unit of an activity that causes the change in activity's cost. For examples:

In distribution business, cost drivers are a number of orders, deliveries, sales return and

disposal of obsolete stock.

Johnson Beverages have to allocate its indirect cost in order to calculate net profit. Cost

drivers can be determined using the Johnson Beverages area of activities such as JB has to

identify first of its all activities that are in addition to production, production is often called

the prime cost that include direct labor, direct material and direct expenses attributable

directly to production.

JB has identified area of activities such as product handling, taking orders from customers,

delivering of orders, expediting orders and deliveries and sales visit to customers. After

analyzing each cost driver than the number of activities should be, recognize in total and each

customer or product in order to attribute a portion of the cost.

Each of the cost drivers of JB can be discussed in detail below,

Product Handling

JB recognizes product handing as the top cost for the company out of total $1.2 Million, the

total cost of product handling which includes handling of beverages in warehouses stand at

the whopping amount of $672,000, which is 56% of total annual customer service cost.

The driver of this cost JB has determined the number of Cases sold; JB is spending 84 cents

to handle each case of beverages.

Ordering Cost
Running Head: Johnson Beverages

Ordering Cost is another cost that comes under customer service cost, the key cost driver is

number of purchase orders or purchase requisition from the customers, the ordering cost per

order JB is spending is $200.

Delivering Cost

Delivering cost includes delivery of product from warehouse to customer’s stores and product

shelving as per customer requirement, the key cost driver costs per delivery, delivery cost is

product of the number of deliveries and miles travelled from warehouse to customer location,

the delivery cost will tend to increase when location of customer is far from JB warehouse.

The cost per mile determined as $3.13 per mile travelled and annual mileage travelled is

44800 miles.

Expediting Delivery Cost

Expedite deliver is rush delivery that JB fulfills when customer order on a rush basis, this

mostly happens when customer unable to maintain enough buffer stock or underestimates the

sales.

Expediting deliver cost JB $79.20 per delivery and total 2500 annual deliveries is expected.

Sales Visit to Customer

For promotion, JB sales teams might visit different super, retail stores in order to make their

potential clients, it is expected there are around 360 visits in total, and cost per visit is

calculated around $250.

Running Head: Johnson Beverages

Suggest alternative cost drivers if it is appropriate and why?

There may be many alternative cost drivers which can be used for better assessment and

allocation of cost to to the customers in order to access the profitability,

More than 56% of customer service cost is attributed to handling cost; it can be argued that

handling cost can be further split into a number of other cost drivers such can be used to

access.

The alternative cost drivers could be storage cost, number of personnel, a number of

marketing campaigns, time allocated to each customer and number of sales return

Calculate customer profitability relevant cost, profitability margin

Profitability calculated using ABC is as follow,

Saver Oscar 's Midwellen Downtown

Supermark
Super store oddlots et Retail
1,168,0 1,192,0 121,5 454,5
Net Revenues 00 00 20 00
1,048,0 1,048,0 104,8 393,0
Cost of goods 00 00 00 00
120,0 144,0 16,7 61,5
Gross Margins 00 00 20 00
Customer Service (75,9 (125,0 (32,3 (43,45
Cost 11) 00) 91) 3)
44,0 19,0 (15,6 18,0
Customer Profits 89 00 71) 47
Customer profits (% of net
revenues) 3.8% 1.6% -12.9% 4.0%

It can be analyzed that by using activity based costing ABC the profitability of each customer

significantly changes.

Downtown retail is most profitable of all earning are $18,047, while Saver super store is

earning $44,089 in profits, these two are top in profitability, while from other two MidWellen

is loss making, earing negative $15, 671 while Oscar odd lots in dollar terms is earning more
Running Head: Johnson Beverages

than most profitable customer which is Downtown retail but profits as percentage of sales in

lower than ratio which is earned by downtown retail.

Make recommendations for customers

Before allocating cost using ABC the customer service cost that is indirect cost was being

allocated as a percentage of sales, which seems to illogical approach and profitability of each

customer was depicting wrong

Before allocating cost using ABC, if decision were to taken to whom JB should continue to

supply than decision would be that JB should discontinue dealings with Saver Super stores

as it only earn profit margin of 0.3% to sales, while JB should focus on Midwellen

supermarket and Downtown Retail which are most profitable customers among others.

However above decision is based on traditional cost based which is indeed depicting wrong

profibilty,after using ABC method the profitability of each customer is as follow,

Saver Super Store

After allocating customer service cost using ABC, Saver super store comes out to be most

profitable customer, the net profit as percentage of sales is 3.8% increase from 0.3%, before

using ABC it was in process to being decide that sales to saver super store should be

discontinue as it is not being profitable but now situation changed.

Oscar’s oddLots

Oscar oddlots profitability decline from 2.1% to 1.6% after allocating cost using ABC,

reflecting true profitability.

Running Head: Johnson Beverages

Midwellen Supermarket

Midwellen supermarket is totally loss making clients as it consume more resources of JB and

JB is earning less profits from this customer, profitability which was 3.8% highest when

using traditional method convert into negative 12.90% when allocating cost using ABC.

Downtown retail

Downtown retail is most profitable customer of all customers given in the case; JB is earning

4% on it, which prior was 2.7% when using traditional cost allocating method.

Conclusion

JB should continue with Downtown retail, saver superstore, and OscarOddlot as they are

profitable from most to least, while JB should immediately discontinue supplier relationship

with Midwellen supermart or increase selling price in order to compensate for the loss.
Running Head: Johnson Beverages

Activity Based
Costing

Total Cost Per

Area of Activity Total Cost Activities Activity $
       
800, $
Product Handling $ 672,000 000 0.84
Taking Orders from $
customer $ 100,000 500 200.00
44, $
Delivering the product $ 140,000 800 3.13
2, $
Expediting deliveries $ 198,000 500 79.20
$
Sales visits to customer $ 90,000 360 250.00

Downtow
  Saver Oscar 's Midwellen n
  Super store oddlots Supermarket Retail
$ $ $
Product Handling Cost $ 67,200.00 67,200.00 6,720.00 25,200.00
$ $ $
Ordering Cost $ 3,200.00 8,000.00 4,000.00 6,000.00
$ $ $
Delivery Cost $ 1,718.75 23,750.00 6,875.00 2,875.00
Expedited Deliveries $ $ $
Cost $ 792.00 19,800.00 10,296.00 7,128.00
$ $ $
Sales visit Cost $ 3,000.00 6,250.00 4,500.00 2,250.00
$ $ $
Total $ 75,910.75 125,000.00 32,391.00 43,453.00