Question 1

ABC Pizza currently has three types of lunch customers: Sit-down, Delivery, and Schools. The Sit-down customers a
following financial information:

Sit-Down Delivery Schools

Number of pizzas 200 100 50
Variable cost per pizza 7 7 4
Number of deliveries 0 59 1

Item Total Cost in$ No

Deliveries 600 Each delivery costs the same amount, regardless of distance or nu
Kitchen 3,818 Costs for the kitchen are largely driven by pizza variable costs
Eat-in area 1,400 This cost is only related to Sit-down customers
Total 5,818 This represents total overhead costs

Required (each of these are separate situations)

A. Assume that ABC does NOT use activity based costing, and instead evenly allocates all costs to each type of piz

B. Assume that ABC uses activity based costing, and each customer type will be charged a different price per pizz
up of 20% (don’t forget to include variable costs).
C. Compare the results in A and B. Which customers will likely be happy/unhappy with Activity Based Costing us

Solution:-
A. Assume that ABC does not use Activity Base Costing
Traditional Approach

Sit-Down Delivery Schools

Number of pizzas 200 100 50
Variable cost per pizza 7 7 4
Number of deliveries 0 59 1

Total Overhead cost $ 5,818.00

Total No. of Pizzas 350
Overhead cost per pizza $ 16.62

For traditional approach, overhead cost are evenly allocated

Sit-Down Delivery Schools

Variable Cost per pizza $ 7.00 $ 7.00 $ 4.00
Overhead Cost per pizza $ 16.62 $ 16.62 $ 16.62
Total cost price per pizza $ 23.62 $ 23.62 $ 20.62
20% Markup $ 4.72 $ 4.72 $ 4.12
Selling price per pizza $ 28.34 $ 28.34 $ 24.74

B. Assume ABC uses activity based costing

 Sit-Down Delivery Schools
Variable Cost per pizza $ 7.00 $ 7.00 $ 4.00
No. of Pizzas 200 100 50
Total variable cost for each type $ 1,400.00 $ 700.00 $ 200.00
Total variable cost

For Activity Based Costing,

Estimated Usage
Activities Total Cost Based On
Sit-Down
Deliveries 600 No. of Deliveries 0
Kitchen 3,818 Variable Costs 1400
Eat-in area 1,400 For Sit Down Customers 1
Total 5,818

Sit-Down Delivery Schools

Variable Cost per pizza $ 7.00 $ 7.00
Overhead Cost per pizza $ 18.62 $ 17.52
Total cost price per pizza $ 25.62 $ 24.52
20% Markup $ 5.12 $ 4.90
Selling price per pizza $ 30.74 $ 29.42
$ 4.00
$ 6.84
$ 10.84
$ 2.17
$ 13.01

C. Compare results in A & B

Selling Price per Pizza

Traditional Approach Activity Based Approach Difference
Sit Down $ 28.34 $ 30.74 $ (2.40)
Delivery $ 28.34 $ 29.42 $ (1.08)
Schools $ 24.74 $ 13.01 $ 11.74

From the above table, it can be seen that by using Activity Based Costing the customer from the school would be ve
The customers from Sit Down and Delivery would be slightly unhappy with the new costing approach.

What would eventually happen if ABC Pizza do not use Activity Based Costing:
1. Cross Subsidization: We can already see that the profits from School are used to offset the losses from Sitdown &
2. Potential for Customer Dissatisfaction: If costs are not accurately allocated, certain customer segments may end
more than their fair share.

3. Difficulty in Cost Control: Without a detailed breakdown of costs by activity, ABC Pizza may struggle to control co
 ools. The Sit-down customers are served in the restaurant, while the Delivery and School customers have their pizza delivered. A typical w

Notes
unt, regardless of distance or number delivered
riven by pizza variable costs
wn customers
sts

ates all costs to each type of pizza. What is the total selling price per pizza if ABC has a mark-up of 20% (don’t forget to include variable c

harged a different price per pizza. What is the total selling price per pizza for each type of customer (Sit-down, Delivery, and Schools) if AB

y with Activity Based Costing used to determine the price per pizza? What will eventually happen if ABC is not adopted?

Total
350
18
60
 $ 2,300.00

Estimated Usage Overhead Cost Allocation

Total Usage Rate per Activity
Delivery Schools Sit-Down Delivery Schools
59 1 60 10 $ - $ 590.00 $ 10.00
700 200 2300 1.66 $ 2,324.00 $ 1,162.00 $ 332.00
0 0 1 1400 $ 1,400.00 $ - $ -
Total Overhead for each type $ 3,724.00 $ 1,752.00 $ 342.00
No. of Pizzas $ 200.00 $ 100.00 $ 50.00
Total Overhead per unit $ 18.62 $ 17.52 $ 6.84

mer from the school would be very happy as they would have to pay less by $11.74.
costing approach.

offset the losses from Sitdown & Delivery customers. This is what cross subsidization is and it distorts profitability picture.
in customer segments may end up subsidizing others. Over time, this could lead to dissatisfaction among customers who feel they are pay

Pizza may struggle to control costs effectively. This could lead to ongoing cost overruns in certain areas without a clear understanding of w
pizza delivered. A typical week has the

forget to include variable costs).

Delivery, and Schools) if ABC has a mark-

adopted?
ity picture.
mers who feel they are paying

a clear understanding of why.