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 customer profitability. The company broke its selling and administrative expenses into five activities as shown below:
Activity Cost Pool (Activity Measure) Total Cost Total Activity
Customer deliveries (Number of deliveries) $ 500,000 5,000 deliveries
Manual order processing (Number of manual orders) 248,000 4,000 orders
Electronic order processing (Number of electronic orders) 200,000 12,500 orders
Line item picking (Number of line items picked) 450,000 450,000 line items
Other organization-sustaining costs (None) 602,000
Total selling and administrative expenses $ 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
Activity Measure University Memorial
Number of deliveries 10 25
Number of manual orders 0 30
Number of electronic orders 15 0
Number of line items picked 120 250
Required:
Compute the total revenue that Worley would receive from University and Memorial.
Answer is complete and correct
Total Revenue
University $ 31,500
Memorial $ 31,500

Computation of Total Revenue from University and Memorial:

Total Cost =                                        $38,541.00

Mark-up (5%)                                        $1,927.05

Total Revenue                                  $40,468.05

Explanation:

a) Data and Calculations:

Activity Cost Pool         (Activity Measure)       Total Cost    Total Activity

Customer deliveries (Number of deliveries)    $ 500,000  5,000 deliveries

Manual order        (Number of manual orders)   248,000  4,000 orders

 processing

Electronic order (Number of electronic orders) 200,000 12,500 orders

processing  

Line item picking (Number of line items picked) 450,000 450,000 line items

Other organization-sustaining costs (None)       602,000

Total selling and administrative expenses  $ 2,000,000

Data on University and Memorial Hospitals:

Activity Measure                     University       Memorial

Number of deliveries                     10                 25  

Number of manual orders              0                 30  

Number of electronic orders        15                   0  

Number of line items picked      120              250

Activity Rates:

Customer deliveries (Number of deliveries)    $ 500,000/5,000 = $100

Manual order        (Number of manual orders)   248,000/4,000   = $62

 processing

Electronic order (Number of electronic orders) 200,000/12,500 = $16

processing  

Line item picking (Number of line items picked) 450,000/450,000 = $1

Other organization-sustaining costs (None)       602,000

Cost of Selling and Administrative Expenses to the two hospitals:

Activity Measure                   University    Memorial Total  Total Cost

Number of deliveries                  10              25           35       $3,500

Number of manual orders           0              30          30        $1,860

Number of electronic orders     15                0            15          $240

Number of line items picked   120           250        370          $370

Total Selling and Administrative Expenses                         $5,970

Cost of medical supplies =                  $30,000

Selling and administrative expenses = $5,970

Fixed costs =                                          $2,571

($5,970/$1,398,000 x $602,000)

Total Cost =                                         $38,541

Mark-up (5%)                                        $1,927.05

Selling price                                      $40,468.05

b) The case stated that both University and Memorial had purchased a total quantity of medical supplies that had cost Worley $30,000 to buy from its manufacturers.  This implies that each hospital did not buy supplies that had cost Worley $30,000 for each.  Based on this assumed fact from the case, the total revenue that Worley would collect from the two hospitals after keying in the selling and distribution and head office fixed costs, to get a total cost of $38,541.00 and adding the 5% markup, the revenue that Worley would receive would be $40,468.05 ($38,541 x 1.05).