Questions

1. What is the difference between activity-based costing and segment profitability analysis? How would you counter
the arguments by other managers concerning the most attractive segments? Using relevant costs provided above,
determine the profitability for each of Happy Chips' business segments.
Answer: Activity-based costing is a method which identifies various activities that cause overhead costs to be
incurred. Here, the cost of resources which are consumed in performing the activities are grouped together to form
Cost Pool and these costs are then assigned to products using a measure of activity i.e., Cost driver.

Segment Profitability analysis:

Whenever a Business or a company caters to different segments, then it is useful to carry out the profitability
analysis on each segment separately.
The difference between both is that the Segment Profitability analysis helps in determining which segment is
profitable. Whereas, Activity Based costing is used to divide overhead costs into different cost pools.

Arguments by other managers:

1. Bill Smith insists on implementing the suggested changes by Buy 4 Less as he thinks that it is an important
customer. But as can be seen from the profitability analysis of Mass Merchandise (which has only Buy 4
less as customer), there is an overall loss of $ 878. Therefore, suggestions by Buy 4 Less should not be
implemented.
2. The argument put forward by Steve Brown (Director of Manufacturing) is absolutely correct. As the
additional expense towards the stickers ($ 5,660) increases the overall expenses of this segment, driving the
profit negative.
 3. Jake Williams (Sales Force) has a valid point in saying that Grocery should be the most important segment
as it is highly profitable.
Profitability of each segment:

Category Grocery Drug Mass Merchandise

Profit $ 7,540.80 $ 1,926.40 $ (878.40)

2. Based on your analysis, should Happy Chips consider the changes desired by Buy 4 Less? Why or why not?
Answer: The profit/loss for the Mass segment if all the changes by Buy 4 Less are implemented will be -$ 13,901, as
detailed below:

Category Mass Merchandise

Annual Unit sales 22,000.00

Trade price per unit $ 1.43
Revenue $ 31,350.00

Expenses
COGS/unit $ 1.05
COGS $ 23,100.00

Stocking cost ($/deivery) $ 2.80

Delivery per week 4
Delivery per year 208
Number of locations to be delivered 3
Total Stocking cost $ 1,747.20

Delivery cost ($/delivery) $ 6.00

Delivery per week 4
Delivery per year 208
Number of locations to be delivered 3
Total delivery cost $ 3,744.00

Information Cost (Annual) $ 1,000.00

Other Manufacturing expense

Sticker annual rental $ 5,000.00
labour and material /unit $ 0.03
labour and material total cost $ 660.00
Other Manufacturing expense $ 5,660.00
 automated order inquiry system $ 10,000.00

Total Expenses $ 45,251.20

Profit $ (13,901.20)
As there is an overall loss by implementing the changes, it is recommended not to follow the suggestions by Buy 4
Less.

3. Should Happy Chips eliminate any business segments? Why or why not?
Answer: Yes, Happy Chips should eliminate the Mass merchandise segment as it is unprofitable. Also, it can try to
make Mass segment profitable by convincing Buy 4 Less that it will not bear the costs towards the stickers.

4. If the price to mass merchandise stores were to increase by 20 percent, would that change your answer to the
previous question?
Answer: Table below shows the profitability analysis if prices increased by 20%:

Category Grocery Drug Mass Merchandise

Annual Unit sales 40000 18000 22000

Trade price per unit $ 2.28 $ 2.76 $ 1.80
Revenue $ 91,200 $ 49,680 $ 39,600

Expenses
COGS/unit $ 1.05 $ 1.05 $ 1.05
COGS $ 42,000.00 $ 18,900.00 $ 23,100.00

Stocking cost ($/delivery) $ 1.80 $ 1.20 $ 2.80

Delivery per week 2 1 3
Delivery per year 104 52 156
Number of locations to be delivered 36 39 3
Total Stocking cost $ 6,739.20 $ 2,433.60 $ 1,310.40

Delivery cost ($/delivery) $ 5.00 $ 5.00 $ 6.00

Delivery per week 2 1 3
Delivery per year 104 52 156
Number of locations to be delivered 36 39 3
Total delivery cost $ 18,720.00 $ 10,140.00 $ 2,808.00

Information Cost (Annual) $ 1,000.00 $ 8,000.00 $ 1,000.00

Other Manufacturing expense

 Sticker annual rental $ 5,000.00
labour and material /unit $ 0.03
labour and material total cost $ 660.00
Other Manufacturing expense $ 5,660.00
Total Expenses $ 68,459.20 $ 39,473.60 $ 33,878.40

Profit $ 22,740.80 $ 10,206.40 $ 5,721.60

As all the segments are profitable, therefore Happy Chips should not eliminate any business segments.

5. Are there factors other than segment profitability that should be considered? If so, what are they?
Answer: Yes, controllable fixed costs like Stocking costs, Delivery costs and Information costs should be considered
carefully. Since, these costs can be controlled i.e., they can be reduced, it becomes important to take them under
consideration in the process of deciding which segments to eliminate.