Question

Question: Using variable costing, service company

Divine 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 August:

Requirements

1. Calculate the contribution margin ratio for each business segment.

2. The business segments had the following number of customers: Byson, 80; Moore, 50; and Freeman, 110. 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?

Short answer

Answer

1. The contribution margin ratio of the Byson, Moore and Freemansegmentsis 70%, 70% and 30% respectively.

Particulars	Byson (80)	Moore (50)	Freeman (110)
Service revenue per customer	$110	$110	$110
Variable cost per customer	$66	$33	$77
Contribution Margin	$44	$77	$33

1. Moore is more profitable organization as it has high contribution because of low profit.

Step-by-step solution

Calculation of contribution margin ratio

Particulars	Byson	Moore	Freeman
Service revenue (a)	$8,800	$5,500	$12,100
Contribution Margin (b)	$3,520	$3,850	$3,630
Contribution margin ratio (b/a)	40%	70%	30%

Calculation of average service revenue per customer, average variable cost per customer and, average contribution margin per customer.

Particulars	Byson (80)	Moore (50)	Freeman (110)
Service revenue per customer	$8,800/80 =$110	$5,500/50 =$110	$12,100/110 =$110
Variable cost per customer	$5,280/80 =$66	$1,650/50 =$33	$8,470/110 =$77
Contribution Margin	$3,520/80 =$44	$3,850/50 =$77	$3,630/110 =$33

Profitability Analysis

Moore is the most profitable segment because the contribution margin per customer is the highest. The reason behind the highest contribution margin is the less variable cost per customer.

The less variable cost will benefit the company in long-run by resulting higher operating profits.Variable cost plays a vital role in operating profit because fixed cost is a sunk cost which does not impact operating profit.