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Dakota Office Products

Goals and objectives


Activity Based Costing/Management (ABC/M) is a tool that helps to explore opportunities for improving profitability of
your company. Unlike traditional cost analysis approaches, ABC/M provides more accurate cost information for each
activity, client/customer and product. Using activity-based approaches can help to overcome the following business
challenges:
Improving sales strategy based on a profitability analysis of various cost objects (clients, products, services, regions and
sales channels)
Planning and controlling how resources are used, identifying wasteful expenditure, and exploring opportunities for cost
reduction without affecting core operations
Establishing the cost of internal functions and considering options for optimising them, including centralisation or
outsourcing.

Exhibit 1 Dakota Office Products: Income Statement CY2000


Sales

4,25,00,000

121.4%

Cost of Items Purchased

3,50,00,000

100.0%

75,00,000
24,00,000
24,00,000
20,00,000
20,00,000

21.4%
6.9%
5.7%

4,50,000
4,50,000
2,00,000
2,00,000
8,00,000
8,00,000
20,00,000
1,20,000
-4,70,000

1.3%
0.6%
2.3%
5.7%
0.3%
-1.3%

Gross margin
Warehouse Personnel Expense
Warehouse Expenses (excluding
personnel)
Freight
Delivery Truck Expenses
Order entry expenses
General and selling expenses
Interest expense
Net Income Before Taxes

Operating Costs

58,50,000

Dakota Office Products


Truck shipment
from
manufacturers
Storage
Location in the
warehouse

Manual
Order

Customer order
receipt

EDI
Order

Collect designated
ordered products
from the
warehouse

Shipment
Preparation
Commerci
al Truck

Desktop
Delivery

Set-Up Manual
Customer Order
(2000 hours)
Validate an EDI
order (500
hours)

Enter
Individual
Oder Lines
(7500 hours)

Validate the
Order

Exhibit 1 Dakota Office Products: Income Statement


CY2000

Process Cartoons
Process Manual Customer Order
Enter Items Ordered
Process EDI Orders
Ship Cartoons
Desktop Delivery

Sales

4,25,00,000

121.4%

Cost of Items Purchased

3,50,00,000

100.0%

75,00,000
24,00,000
20,00,000

21.4%
6.9%
5.7%

4,50,000
2,00,000
8,00,000
20,00,000
1,20,000
-4,70,000

1.3%
0.6%
2.3%
5.7%
0.3%
-1.3%

Gross margin
Warehouse Personnel Expense
Warehouse Expenses
(excluding personnel)
Freight
Delivery Truck Expenses
Order entry expenses
General and selling expenses
Interest expense
Net Income Before Taxes

Exhibit 2 Customer Profitability Report (Current Method)


Customer A
Sales
Cost of Items Purchased

Gross margin
Warehousing, Distribution and
Order Entry

Contribution to general and


selling expenses, and profit

Customer B

1,03,000
85,000

121.2%
100.0%

1,04,000
85,000

122.4%
100.0%

18,000
12,750

21.2%
15.0%

19,000
12,750

22.4%
15.0%

5,250

6.2%

6,250

7.4%

Exhibit 3 Services Provided in Year 2000 to Customers A and B

Number of cartons ordered


Number of cartons shipped commercial
freight

Number of desktop deliveries


Number of orders, manual
Number of line items, manual
Number of EDI orders
Average accounts receivable

Customer A
200
200

Customer B
200
150

6
60
6
$9,000

25
100
180
$30,000

Customer A
Sales
Cost of Items
Purchased
Gross margin
Number of cartons
200
Number of cartons
shipped, commercial
freight
200
Number of Dextop
Deliveries
Number of orders
mannual
6
Number of line items,
mannual order
60
Number of EDI Orders
6
Average Accounts
Receivables
$9000
Customer contribution

Customer B

1,03,000
85,000

1,04,000
85,000

18,000
10400

200

19,000
10400

1200

150

900

25

5500

60

100

1000

240
30

180

720

900 $30000
12830
5,170

3000
21520
-2,520

Kronecker Company, a growing mail order clothing and accessory


company, is concerned about its growing marketing, distribution, selling
and administration expenses.
It therefore examined its customer ordering patterns for the past year and
identified four different types of customers, as illustrated in the following
table.
Kronecker sends catalogs and flyers to all its customers several times a
year. Orders are taken by mail or over the phone by the toll free number.
Kronecker prides it self on the personal attention it provides shoppers
who order over the phone.
All purchases are paid for by check or credit card. It also maintains a very
generous return policy if customers are not satisfied with the product.
Customers must pay return shipping charges, but their purchase price is
then fully refunded.

Customer 1

Customer 2

Customer 3

Customer 4

Initial Sales

Rs. 1000

Rs. 1000

Rs. 2,500

Rs. 3,000

Number of items returned

24

Dollar value of items returned

Rs. 200

Rs. 500

Rs. 1,500

Number of orders per year

12

Number of phone orders per year

12

Time spent on phone placing orders

0.25 hour

1 hour

Number of overnight delivery

12

Number of regular delivery

Prices are set so that cost of goods sold is on


average about 75% of the sales price.
Customers pay actual shipping charges, but
extra processing is required for overnight
delivery. The company has developed the
following activity cost driver rates for its
support costs. What advice will you give to
the company.

Activity

Activity Cost
Driver Rate
(Rs.)

Process mail orders

Process phone orders

80

Process returns

Process over night delivery


request

Maintain customer relations

50

Customer 1

Sales
Less returns
Net sales
Cost of goods sold,
75% of sales
Processing mail orders,
$5 per nonphone order

Customer 2

Customer 3

Customer-4

$1,000
0
$1,000

$1,000
200
$800

$2,500
500
$2,000

$3,000
1,500
$1,500

750

600

1,500

1,125

30

20

Process phone orders,


$80 per hour

20

80

Process returns,
$5 per item returned

20

10

120

48

50

50

50

50

$176
0.18

$100
0.10

$420
0.17

$77
0.03

Process overnight
delivery requests,
$4 per request

Customer 4
is the
most
expensive

Customer 1 is fairly
low-cost to serve

Maintain customer
relations
Profit
Profit Sales

11

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