Dakota Office Products Case 1. Why was Dakota’s existing pricing system inadequate for its current operating environment?
Some problems with the current operating environment include:
Profits only when clients placed large orders for cartons Real drop of profit when many clients place small orders Wrong cost determination for individual customers Wrong cost determination for new services provided by DOP
Dakota Office Product uses traditional costing system where direct and indirect costs are assigned and allocated to products and services delivered to customers. This is better for companies where production operations are high labor intensive and overhead costs are smaller part of total costs. Activity Based Costing is going to be better for Dakota Office Products. They will be able to calculate the cost of products and services in accordance to the activities involved and resources consumed.
2. Develop an activity-based cost system for Dakota Office Products (DOP) based on Year 2000 data. Calculate the activity cost-driver rate for each DOP activity in 2000. Activity cost-driver rates: Activity One: process cartons in and out of the facility Rate=(90% of Warehouse Personnel Expense + Cost of Items Purchased)/cartons processed Rate=(90%*2,400,000+35,000,000)/80,000= $464.5 /per carton Activity Two: the new desktop delivery service Rate=(10% of Warehouse Personnel Expense + Delivery Truck Expenses)/desktop deliveries Rate=(10%*2,400,000+200,000)/2000= $220 /per carton Activity Three: order handling Rate= (Warehouse Expenses + Freight)/ number of orders Rate=(2,000,000+450,000)/(16,000+8,000)=$102.08 /per order
Activity Four: data entry Rate=Order entry expenses/Order lines Rate=800,000/150,000= $5.3 orders/per line
3. Using your answer to Question 2, calculate the profitability of Customer A and Customer B.
Activity
Cost driver rate
Customer A
Process cartons in and out of the facility
$464.5 carton
The new desktop delivery price
$220/desktop deliveries
Order handling
102.08/per order
Data entry
Total Cost Sales Profit
per 92,900 (464.4*200 cartons)
Customer B 92,900 (464.4*200 cartons)
5,500 (220*25desktop deliveries) 10,208 (102.08*100 orders)
1,224.96 (102.08*12 orders) 5.3 per line 318 (5.3*60 line 954 (5.3*180 line item items) items) 94,442.96 1,03,000 8557.04
1,09,562 10,4000 (5562)
4. What explains any difference in profitability between the two custom The increase in cost due to increase in number of both manual and EDI orders has led to lower profitability of Customer B when compared to Customer A.
5. What are the limitations, if any, to the estimates of the profitability of the two customers? Limitations include correctly estimating cost pools and correctly determining the cost drivers.
6. Is there any additional information you would like to have to explain the relative profitability of the two customers? Knowing the profitability rate could help the company get higher sales per customer. They could raise the prices of their services for the more profitable customers and cut prices on some services used by their less profitable customers.
7. Assume that Dakota applies the analysis done in Question 3 to its entire customer base. How could such information help the Dakota managers increase company profits? Dakota should do an analysis with all of its customers. This could identify the customers who they would profit from the most and then they could minimize services to the least profitable customers and concentrate on the more profitable customers. Also if they did an analysis, they would figure out that the delivery cost has some issue and the price for desktop delivery should be adjusted by the distance from the warehouse.
8. Suppose that a major customer switched from placing all its orders manually to placing all its orders over the internet site. How should this affect the activity cost driver rates calculated in Question 2? How would the switch affect Dakota’s profitability? The activity cost driver rates would increase if the major customer switched. This switch would increase DOP’s Profits because of less indirect time and activity costs. The manual cost driver would go down and desktop delivery charge driver would increase.
