You are a management accountant at Delots Management Consultants. You have been approached by Pharmaguard Ltd regarding implementing Activity-based Costing (ABC) in its retail operations. The company has three main market segments:
• General supermarket chains
• Pharmacy chains
• Pharmacist-owned single stores
For many years, Pharmaguard has used gross margin percentage [(Revenue - Cost of goods sold) ÷ Revenue] to evaluate the relative profitability of its market segments.
Pharmaguard’s segmental profit information for 2015 is given below:
Pharmaguard Ltd, 2015 General supermarket chains Pharmacy chains Pharmacist-owned single stores Pharmaguard Ltd
Revenues $3 708 000 $3 150 000 $1 980 000 $8 838 000
Cost of goods sold 3 600 000 3 000 000 1 800 000 8 400 000
Gross margin $108 000 $150 000 $180 000 438 000
Other operating costs 301 080
Operating profit $136 920
In your meetings with Pharmaguard staff, you have undertaken a value or activity analysis, where you have classified activities as value-added or non-value added. You have identified the five key activities that drive other operating costs at Pharmaguard:
Activity area Cost driver
Order processing Number of customer purchase orders
Line-item processing Number of line items ordered by customers
Delivering to stores Number of store deliveries
Cartons shipped to store Number of cartons shipped
Stocking of customer store shelves Hours of shelf-stocking
The level of each activity in the three market segments and the total cost incurred for each activity in 2015 is shown below:
Activity-based cost data Activity level
Activity General supermarket chains Pharmacy chains Pharmacist-owned single stores Total cost of activity in 2015
Orders processed (number) 140 360 1 500 $80 000
Line-items ordered (number) 1 960 4 320 15 000 63 840
Store deliveries made (number) 120 360 1 000 71 000
Cartons shipped to stores (number) 36 000 24 000 16 000 76 000
Shelf-stocking (hours) 360 180 100 10 240
a. Compute the 2015 gross-margin percentage for each of Pharmaguard’s three market segments.
b. Compute the cost driver rates for each of the five activity areas.
c. Use the activity-based costing information to allocate the $301080 of “other operating costs” to each of the market segments. Compute the operating profit for each market segment.
d. Comment on the results. What new insights are available with the ABC information?
e. The senior management at Phramaguard plans to implement ABC in its retail operations, manufacturing operations and its medical centre operations. The staff in these divisions are not in favour of implementing ABC and the Activity-based management (ABM). They are resisting these changes. Some employees are questioning, “why does the company need to change at all”?
f. As a consultant, give your professional advice on the benefits and limitations of adopting ABC for all its all operations at Pharmaguard.
You need to present both parts -- your computational work and advice -- in a professional business report format.