13-27 Target service costs, value engineering, activity-based costing. Lagoon is

Question

13-27 Target service costs, value engineering, activity-based costing. Lagoon is an amusement park that offers family-friendly entertainment and attractions. The park boasts more than 25 acres of fun. The admission price to enter the park, which includes access to all attractions, is $35. At this entrance price, Lagoon’s target profit is 35% of revenues. Lagoon’s managers have identified the major activities that drive the cost of operating the park. The activity cost pools, the cost driver for each activity, and the cost per unit of the cost driver for each pool are:

cost driver for each pool are:

Activity

Description of Activity

Cost Driver

Cost per Unit of Cost Driver

1. Ticket sales

Selling tickets on-site for entry into the park

Number of tickets sold on-site

$2 per ticket sold

2. Ticket verification

Verifying tickets purchased at park and online ticket purchases

Number of patrons

$1.50 per patron

3. Operating attractions

Loading, monitoring, off-loading patrons on attraction

Number of runs

$90 per run

4. Litter patrol

Roaming the park and cleaning up waste as necessary

Number of litter patrol hours

$20 per hour

The following additional information describes the existing operations:

a. The park operating hours are 10:00 a.m.8:00 p.m., 7 days a week. The average number of patrons per week is 55,000.

b. Lagoon maintains an online Web site for advance ticket purchases. This site is maintained by an outside company that charges $1 per ticket sold. Only 15% of the tickets are purchased online.

c. Once the ticket is purchased, another park employee checks the ticket and stamps the patron for potential exit and reentry.

d. The park has 27 attractions. A run is the complete cycle of loading, monitoring, and off-loading of patrons. On average, the attractions can make 6 runs an hour. The cost of operating the attractions includes wages of operator, maintenance, and depreciation of equipment.

e. Cleaning crew members are assigned to 1-acre areas. One person can cover approximately 1 acre per hour. Each acre is covered continuously. The cost of litter patrol includes the wages of the employee and cleaning supplies.

In response to competitive pressures and to continue to attract 55,000 patrons per week, Lagoon has decided to lower ticket prices to $33 per patron. To maintain the same level of profits as before, Lagoon is looking to make the following improvements to reduce operating costs:

a. Spend $1,000 per week on advertising to promote awareness of the available online ticket purchase. Lagoon’s managers expect that this advertising will increase online purchases to 40% of total ticket sales. At this volume, the cost per online ticket sold will decrease to $0.75.

b. Reduce the operating hours for eight of the attractions that are not very popular from 10 hours per day to 7 hours per day.

c. Increase the number of refuse containers in the park at an additional cost of $250 per week. Litter patrol employees will be able to cover 1.25 acres per hour.

The cost per unit of cost driver for all other activities will remain the same.

Required

1. Does Lagoon currently achieve its target profit of 35% of sales?

2. Will the new changes and improvements allow Lagoon to achieve the same target profit in dollars? Show your calculations.

3. What challenges might managers at Lagoon encounter in achieving the target cost? How might they overcome these challenges?

Activity

Description of Activity

Cost Driver

Cost per Unit of Cost Driver

1. Ticket sales

Selling tickets on-site for entry into the park

Number of tickets sold on-site

$2 per ticket sold

2. Ticket verification

Verifying tickets purchased at park and online ticket purchases

Number of patrons

$1.50 per patron

3. Operating attractions

Loading, monitoring, off-loading patrons on attraction

Number of runs

$90 per run

4. Litter patrol

Roaming the park and cleaning up waste as necessary

Number of litter patrol hours

$20 per hour

Explanation / Answer

1. Current revenues are 55000 x $ 35 =$ 1,925,000. Therefore target profit at 35% is $ 673,750

The amusement park at present operates 10 hrs./day x 7 days = 70 hours per week

Number of runs is 27 attractions x 6 runs per hour x 70 hours = 27 x 6 70 = 11,340 runs

Weekly Income Statement

Yes, Lagoon currently does acheive more than its target profit of 35%

2. Proposed Weekly Income Statement

Ticket sales

The proposed changes will Lagoon to achieve more than the same target profit in dollars

3. The main concern for the management should be the recovery of fixed overdeads, given the reduced scale of operations. Fixed costs are not likely to remain at the same level forever. Sooner or later, they are bound to increase, and the proposed strategy may not succeed in maintaining the desired level of profit in the long run.

Secondly, with reduced staff, upkeep and maintenance of the grounds may pose another challenge.

$ $ Total revenues 1,925,000 Less activity wise cost Ticket sales Onsite 55,000 x 85% x 2 93,500 Online 55,000 x 15% x 1 8,250 (101,750) Ticket verification 55,000 x 1.5 (82,500) Operating attractions 11,340 hours @ $ 90 per hour (1,020,600) Litter patrol 25 acres x 70 hours x $ 20 per hour (35,000) Profit/(Loss) 685,150

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