14 - 1 Cost Allocation, Customer- Profitability Analysis, and Sales-Variance Analysis Chapter 14

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Cost Allocation, Customer-Profitability Analysis, and

Sales-Variance Analysis

Cost Allocation, Customer-Profitability Analysis, and

Sales-Variance Analysis

Chapter 14

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Learning Objective 1Learning Objective 1

Identify four purposes

for allocating costs to

cost objects.

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Purposes of Cost AllocationPurposes of Cost Allocation

1. To provide information for economic decisions

2. To motivate managers and other employees

3. To justify costs or compute reimbursement

4. To measure income and assets for reportingto external parties

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Guide cost-allocation decisions

using appropriate criteria.

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Criteria to GuideCost-Allocation Decisions


Cause-and-effect:Using this criterion, managers identify thevariable or variables that cause resources

to be consumed.

Benefits-received:Using this criterion, managers identify the

beneficiaries of the outputs of the cost object.

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Fairness or equity:This criterion is often cited on government

contracts when cost allocations are the basisfor establishing a price satisfactory to the

government and its suppliers.

Ability to bear:This criterion advocates allocating costs in proportion

to the cost object’s ability to bear them.

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Role of Dominant CriteriaRole of Dominant Criteria

The cause-and-effectand the benefits-received criteria

guide mostdecisions related

to cost allocations.

Fairness and abilityto bear are lessfrequently used.

Why?

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Role of Dominant CriteriaRole of Dominant Criteria

Fairness is an especially difficult criterionto obtain agreement on.

The ability to bear criterion raises issuesrelated to cross-subsidization across users

of resources in an organization.

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Discuss decisions faced

when collecting costs in

indirect-cost pools.

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Cost Allocation andCosting Systems Example


Smith Corporation manufactures clotheswashers and dryers in two divisions:

Clothes Washer Division in Canton (CWD)

Clothes Dryer Division in Dayton (CDD)

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Corporate costs:Treasury $ 600,000Human resources $1,200,000Administration $4,800,000

Treasury cost is interest to financeequipment acquisition of $4,000,000in Canton and $2,000,000 in Dayton.

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Division costs: Canton DaytonDirect costs $2,200,000 $4,000,000Indirect costs 1,980,000 2,500,000Total $4,180,000 $6,500,000

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If Smith Corporation allocates corporatecosts to divisions, how many cost poolsshould it use to allocate corporate costs?

One single cost pool?

Numerous individual corporate cost pools?

A key factor is the concept of homogeneity.

Which allocation basis should SmithCorporation use to allocate treasury costs?

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Treasury costs: $600,000

Canton Division:$600,000 × ($4,000,000 ÷ $6,000,000) = $400,000

Dayton Division:$600,000 × ($2,000,000 ÷ $6,000,000) = $200,000

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Smith Corporation allocates humanresources on the basis of total directlabor costs incurred in each division.

Suppose direct labor costs in Canton are$1,200,000 and $1,800,000 in Dayton.

How does Smith Corporation allocate its$1,200,000 of human resources costs?

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Canton Division:$1,200,000 × ($1,200,000 ÷ $3,000,000)

= $480,000

Dayton Division:$1,200,000 × ($1,800,000 ÷ $3,000,000)

= $720,000

Smith does not allocate corporateadministration costs to the divisions.

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Canton DaytonTreasury costs:$600,000 (2/3 and 1/3) $400,000 $200,000Human resources costs:$1,200,000 40% and 60% 480,000 720,000Total allocated to divisions $880,000 $920,000

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77

Toledo Cleveland

Akron

Canton

Columbus

Cincinnati

Dayton

Grea t Miam iRive r

MuskingumRiver

OhioRiver

OhioRiver

OHIO

70

75

80

90

90

71

76

Treasury costs arereallocated by the

divisions to Assembly.

Human resources costsare reallocated by thedivisions to the Dept.of Human Resources.

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Canton Division

Finishingdirect costs:

$900,000

Assembly direct costs $1,300,000Corporate costs 400,000Total costs $1,700,000

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Canton Division

Maintenancedirect costs:

$300,000

Human Resources direct costs: $1,680,000Corporate costs: 480,000Total costs $2,160,000

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Canton Division$5,060,000

Assembly Dept.$1,700,000

Finishing Dept.$900,000

Maintenance Dept.$300,000

Human Resources Dept.$2,160,000

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Discuss why a company’s

revenues can differ across

customers purchasing

the same product.

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Customer RevenueAnalysis ExampleCustomer RevenueAnalysis Example

During the first six months of 2003,English Languages Institute expandedits market and sold 200 composition

programs to two new customers in Mexico.

Customer A is in Tijuana andcustomer B is in Guadalajara.

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Customer A B

Programs sold 140 60List selling price $185 $185Invoice price $175 $180Total revenues $24,500 $10,800

What explanation(s) can be given forthese revenue differences?

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1. The volume of programs purchased

2. The magnitude of price discounting

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Customer Cost Analysis ExampleCustomer Cost Analysis Example

Assume that English Languages Institutehas an activity-based costing system that

focuses on customers rather than products.

Activity Area Cost Driver and RateOrder taking $ 80 per purchaseOrder set up $100 per batch

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Customer A Customer BNumber of:Purchase orders 7 2Batches 7 2

What is the cost of servicing each customer?

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Customer A:Ordering: 7 × $80/order = $ 560Set-up: 7 × $100/batch = 700Total $1,260

English can use this information to persuadethis customer to reduce usage of the

ordering and setup cost drivers.

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Customer B:Ordering: 2 × $80/order = $160Setup: 2 × $100/batch = 200Total $360

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Apply the concept of cost

hierarchy to customer costing.

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Cost HierarchyCost Hierarchy

General Motors uses a seven-level costhierarchy to analyze profitability.

The aim of this cost hierarchy is to assigncosts to the lowest level of the hierarchy

at which they can be identified.

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Cost HierarchyCost Hierarchy

1. Enterprise-related activities

2. Market-related activities

3. Channel-related activities

4. Customer-related activities

5. Order-related activities

6. Parts-related activities

7. Direct materials

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Discuss why customer-profitabilitydiffers across customers.

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Customer-Profitability ProfilesCustomer-Profitability Profiles

Which customer is more profitable, A or B?

A BRevenues $24,500 $10,800Cost of good sold ($95 per unit) 13,300 5,700Contribution margin $11,200 $ 5,100Other expenses 1,260 360Operating income $ 9,940 $ 4,740

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Customer-Profitability ProfilesCustomer-Profitability Profiles

Customer A seems to be more profitable.

However, customer B has a higher grossprofit percentage.

Customer A has a gross profit of 40.6%($9,940 ÷ $24,500).

Customer B has a gross profit of 43.9%($4,740 ÷ $10,800).

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Provide additional information

about the sales-volume variance by

calculating the sales-mix variance

and the sales-quantity variance.

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Sales-VolumeVariance Components


The following information relates to EnglishLanguages Institute budget for the year 2003.

Product Grammar Trans. Comp.Selling price per unit $259 $87 $185Variable cost 189 50 95Contribution margin per unit $ 70 $37 $ 90

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Product Grammar Translation Composition

Cont. margin $70 $37 $90

× Units 3,185 980 735

= Total $222,950 $36,260 $66,150

Sales mix 65% 20% 15%

Total budgeted contribution margin = $325,360

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Selling $/unit $255 $85 $185

Variable cost 180 45 95

Cont. marginper unit

$ 75 $40 $ 90

The following are the actual results forEnglish Languages for the year 2003.

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Cont. margin $75 $40 $90

× Units 2,880 990 630

= Total $216,000 $39,600 $56,700

Sales mix 64% 22% 14%

Total actual contribution margin = $312,300

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Static-Budget VarianceStatic-Budget Variance

Static- Static- Actual budget budget

Product results amount varianceGrammar $216,000 $222,950 $ 6,950 UTranslation 39,600 36,260 3,340 FComposition 56,700 66,150 9,450 U Total $312,300 $325,360 $13,060 U

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Flexible-Budget VarianceFlexible-Budget Variance

Actual contribution Unit Actual

Product margin/unit volume resultsGrammar $75 2,880 $216,000Translation $40 990 $ 39,600Composition $90 630 $ 56,700

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Budgeted Actual contribution unit Flexible

Product margin/unit volume budgetGrammar $70 2,880 $201,600Translation $37 990 $ 36,630Composition $90 630 $ 56,700

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Flexible- Flexible- Actual budget budget

Product results amount varianceGrammar $216,000 $201,600 $14,400 FTranslation $39,600 $ 36,630 $ 2,970 FComposition $56,700 $ 56,700 0Total flexible-budget variance $17,370 F

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Sales-Volume VarianceSales-Volume Variance

Budgetedcontribution

Product Actual Budget margin Grammar (2,880 – 3,185) × $70 = $21,350 U Translation (990 – 980) × $37 = 370 FComposition (630 – 735) × $90 = 9,450 UTotal sales-volume variance $30,430 U

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Sales-Mix VarianceSales-Mix Variance

Sales-mix variance

Actual units of all products sold

Actual sales-mix percentage– Budgeted sales-mix percentage

Budgeted contribution margin per unit

=

×

×

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Sales-Mix VarianceSales-Mix Variance

Grammar: 4,500(0.64 – 0.65) × $70 = $3,150 U

Translation: 4,500(0.22 – 0.20) × $37 = $3,330 F

Composition: 4,500(0.14 – 0.15) × $90 = $4,050 U

Total sales-mix variance = $3,870 U

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Sales-Quantity VarianceSales-Quantity Variance

Sales-quantity variance

Actual units of all products sold– Budgeted units of all products sold

Budgeted sales-mix percentage

Budgeted contribution margin per unit

=

××

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Sales-Quantity VarianceSales-Quantity Variance

Grammar: (4,500 – 4,900) × 0.65 × $70 = $18,200 U

Translation: (4,500 – 4,900) × 0.20 × $37 = $ 2,960 U

Composition: (4,500 – 4,900) × 0.15 × $90 = $ 5,400 U

Total sales-quantity variance = $26,560 U

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Provide additional information

about the sales-quantity variance

by calculating the market-share

variance and the

market-size variance.

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Market-Share Variance ExampleMarket-Share Variance Example

Assume that English Languages Institute derivesits total unit sales budget for 2003 from a

management estimate of a 20% market shareand a total industry sales forecast by Desert

Services of 24,500 units in the region.

In 2003, Desert Services reported actualindustry sales of 28,125 units.

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What is English’s actual market share?

4,500 ÷ 28,125 = 0.16

Budgeted total contribution margin is $325,360.

Budgeted number of units is 4,900.

What is the budgeted averagecontribution margin per unit?

$325,360 ÷ 4,900 = $66.40

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What is the market-share variance?

Actual market size in units

Actual market share– Budgeted market share

Budgeted contribution margin percomposite unit for budgeted mix

=

×

×

28,125(0.16 – 0.20) × $66.40 = $74,700 U

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Actual Market Size × Actual Market Share× Budgeted Average Contribution Margin Per Unit

28,125 × 0.16 × $66.40 = $298,800

Actual Market Size × Budgeted Market Share× Budgeted Average Contribution Margin Per Unit

28,125 × 0.20 × $66.40 = $373,500

$373,500 – $298,800 = $74,700 U

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Market-Size Variance ExampleMarket-Size Variance Example

Market-size variance

Actual market size in units– Budgeted market size in units

Budgeted market share

Budgeted contribution margin percomposite unit for budgeted mix

=

×

×

(28,125 – 24,500) × 0.20 × $66.40 = $48,140 F

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Market-Size Variance ExampleMarket-Size Variance Example

Actual Market Size × Budgeted Market Share× Budgeted Average Contribution Margin Per Unit

28,125 × 0.20 × $66.40 = $373,500

Static Budget: Budgeted Market Size× Budgeted market share

× Budgeted Average Contribution Margin Per Unit24,500 × 0.20 × $66.40 = $325,360

$373,500 – $325,360 = $48,140 F

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Summary of VariancesSummary of Variances

Static-Budget Variance13,060 U

Level 1

Level 2Flexible-Budget

Variance$17,370 F

Sales-VolumeVariance

$30,430 U

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Sales-Volume Variance$30,430 U

Level 2

Level 3Sales-MixVariance$3,870 U

Sales-QuantityVariance

$26,560 U

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Sales-Quantity Variance$26,560 U

Level 3

Level 4Market-Share

Variance$74,700 U

Market-SizeVariance$48,140 F

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End of Chapter 14End of Chapter 14

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14 - 1 Cost Allocation, Customer- Profitability Analysis, and Sales-Variance Analysis Chapter 14