Q31PGA - Horngren'S Financial And Managerial Accounting

Question

Using variable costing, service company 

Professional Pool Cleaning Service provides pool cleaning services to residential customers. The company has three employees, each assigned to specific customers. The company considers each employee’s territory as a business segment. The company incurs variable costs that include the employees’ wages, pool chemicals, and gas for the service vans. Fixed costs include depreciation on the service vans. Following is the income statement for the month of July:

 

 

Requirements

1. Calculate the contribution margin ratio for each business segment. 
2. The business segments had the following numbers of customers: Birman, 60; Meech, 70; and Frond, 40. Compute the service revenue per customer, variable cost per customer, and contribution margin per customer for each business segment. 
3. Which business segment was most profitable? List some possible reasons why this segment was most profitable. How might the various reasons affect the company in the long term?

Step-by-Step Solution

Answer

1. The Contribution Margin ratio for Birman, Meech, and Frond is 50%, 30%, and 40%.
2. Service revenue per customer for each business segment is $50.Variable cost per customer for Birman, Meech, and Frond is $25, $35, and $30 respectively. The contribution margin per customer for Birman, Meech, and Frond is $25, $15, and $20.

1. Birman's business segment is most profitable because of its lower variable cost. It may affect the organization in both positive or negative manner depending on the reason of low variable cost.  

Step 1: Calculation of the contribution margin ratio for each business segment (1)

Particulars	Birman	Meech	Frond
Service revenue	$3,000	$3,500	$2,000
Variable cost	$1,500	$2,450	$1,200
Contribution Margin	$1,500	$1,050	$800
Contribution margin ratio	50%	30%	40%

Step 2: Calculation of average service revenue per customer, average variable cost per customer, and, average contribution margin per customer.(2)

Particulars	Birman	Meech	Frond
Service revenue	$3,000/60 =$50	$3,500/70 =$50	$2,000/40 =$50
Variable cost	$1,500/60 =$25	$2,450/70 =$35	$1,200/40 =$30
Contribution Margin	$1,500/60 =$25	$1,050/70 =$15	$800/40  =$20

Step 3: Profitability analysis (3)

Birman is the most profitable business segment because it has the highest contribution margin. It is the most profitable segment because it has the lowest variable cost per unit.The lowest variable cost may be because of low wages, poor quality of chemicals used for cleaning, etc. This leads to high employee turnover and dissatisfied customers which cause both financial and reputational loss. If it is because of efficient utilization of resources whether it's human resources or others it leads to high profitability.