MBA - Krajewski

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    Cost Allocation, Customer-

    Profitability Analysis, andSales-Variance Analysis

    Chapter 14

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    Learning Objective 1

    Identify four purposes

    for allocating costs to

    cost objects.

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    Purposes 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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    Learning Objective 2

    Guide cost-allocation decisions

    using appropriate criteria.

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    Criteria to Guide

    Cost-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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    Criteria to Guide

    Cost-Allocation DecisionsFairness or equity:

    This criterion is often cited on government

    contracts when cost allocations are the basis

    for establishing a price satisfactory to the

    government and its suppliers.

    Ability to bear:

    This criterion advocates allocating costs in proportion

    to the cost objects ability to bear them.

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    Role of Dominant CriteriaThe cause-and-effect

    and the benefits-

    received criteriaguide most

    decisions related

    to cost allocations.

    Fairness and abilityto bear are less

    frequently used.

    Why?

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    Role of Dominant Criteria

    Fairness is an especially difficult criterion

    to obtain agreement on.The ability to bear criterion raises issues

    related to cross-subsidization across users

    of resources in an organization.

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    Learning Objective 3

    Discuss decisions faced

    when collecting costs in

    indirect-cost pools.

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    Cost Allocation and

    Costing Systems Example

    Smith Corporation manufactures clothes

    washers and dryers in two divisions:Clothes Washer Division in Canton (CWD)

    Clothes Dryer Division in Dayton (CDD)

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    Cost Allocation and

    Costing Systems Example

    Corporate costs:

    Treasury $ 600,000Human resources $1,200,000

    Administration $4,800,000

    Treasury cost is interest to financeequipment acquisition of $4,000,000

    in Canton and $2,000,000 in Dayton.

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    Cost Allocation and

    Costing Systems Example

    Division costs: Canton Dayton

    Direct costs $2,200,000 $4,000,000Indirect costs 1,980,000 2,500,000

    Total $4,180,000 $6,500,000

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    Cost Allocation and

    Costing Systems Example

    If Smith Corporation allocates corporate

    costs to divisions, how many cost pools

    should 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 Smith

    Corporation use to allocate treasury costs?

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    Cost Allocation and

    Costing Systems Example

    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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    Cost Allocation and

    Costing Systems Example

    Smith Corporation allocates human

    resources on the basis of total direct

    labor 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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    Cost Allocation and

    Costing Systems Example

    Canton Division:

    $1,200,000 ($1,200,000 $3,000,000)

    = $480,000Dayton Division:

    $1,200,000 ($1,800,000 $3,000,000)

    = $720,000Smith does not allocate corporate

    administration costs to the divisions.

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    Cost Allocation and

    Costing Systems Example

    77

    Toledo Cleveland

    AkronCanton

    Columbus

    Cincinnati

    Dayton

    G re a t Mia m i

    Rive r

    Muskingum

    River

    Ohio

    River

    Ohio

    River

    OHIO

    70

    75

    80

    90

    90

    71

    76

    Treasury costs are

    reallocated by the

    divisions to Assembly.

    Human resources costs

    are reallocated by thedivisions to the Dept.

    of Human Resources.

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    Cost Allocation and

    Costing Systems Example

    Canton Division

    Finishing

    direct costs:

    $900,000

    Assembly

    direct costs $1,300,000Corporate costs 400,000

    Total costs $1,700,000

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    Cost Allocation and

    Costing Systems Example

    Canton Division

    Maintenance

    direct costs:

    $300,000

    Human Resources

    direct costs: $1,680,000Corporate costs: 480,000

    Total costs $2,160,000

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    Cost Allocation and

    Costing Systems Example

    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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    Learning Objective 4

    Discuss why a companys

    revenues can differ across

    customers purchasing

    the same product.

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    Customer Revenue

    Analysis 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 Revenue

    Analysis Example

    Customer

    A B

    Programs sold 140 60List selling price $185 $185

    Invoice price $175 $180

    Total revenues $24,500 $10,800What explanation(s) can be given for

    these revenue differences?

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    Customer Revenue

    Analysis Example

    1. The volume of programs purchased

    2. The magnitude of price discounting

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    Customer Cost Analysis Example

    Assume that English Languages Institute

    has an activity-based costing system thatfocuses on customers rather than products.

    Activity Area Cost Driver and Rate

    Order taking $ 80 per purchaseOrder set up $100 per batch

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    Customer Cost Analysis Example

    Customer A Customer B

    Number of:Purchase orders 7 2

    Batches 7 2

    What is the cost of servicing each customer?

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    Customer Cost Analysis Example

    Customer A:

    Ordering: 7 $80/order = $ 560Set-up: 7 $100/batch = 700

    Total $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 Cost Analysis Example

    Customer B:

    Ordering: 2 $80/order = $160Setup: 2 $100/batch = 200

    Total $360

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    Learning Objective 5

    Apply the concept of cost

    hierarchy to customer costing.

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    Cost Hierarchy

    General Motors uses a seven-level cost

    hierarchy to analyze profitability.The aim of this cost hierarchy is to assign

    costs to the lowest level of the hierarchy

    at which they can be identified.

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    Cost Hierarchy

    1. Enterprise-related activities

    2. Market-related activities

    3. Channel-related activities

    4. Customer-related activities

    5. Order-related activities6. Parts-related activities

    7. Direct materials

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    Learning Objective 6

    Discuss why customer-profitability

    differs across customers.

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    Customer-Profitability Profiles

    Which customer is more profitable, A or B?

    A BRevenues $24,500 $10,800

    Cost of good sold ($95 per unit) 13,300 5,700

    Contribution margin $11,200 $ 5,100Other expenses 1,260 360

    Operating income $ 9,940 $ 4,740

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    Customer-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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    Learning Objective 7

    Provide additional information

    about the sales-volume variance by

    calculating the sales-mix variance

    and the sales-quantity variance.

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    Sales-Volume

    Variance Components

    The following information relates to English

    Languages Institute budgetfor the year 2003.Product Grammar Trans. Comp.

    Selling price per unit $259 $87 $185

    Variable cost 189 50 95Contribution margin per unit $ 70 $37 $ 90

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    Sales-Volume

    Variance Components

    Product Grammar Translation Composition

    Cont. margin $70 $37 $90Units 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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    Sales-Volume

    Variance Components

    Product Grammar Translation Composition

    Selling $/unit $255 $85 $185

    Variable cost 180 45 95

    Cont. margin

    per unit$ 75 $40 $ 90

    The following are the actual results for

    English Languages for the year 2003.

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    Sales-Volume

    Variance Components

    Product Grammar Translation Composition

    Cont. margin $75 $40 $90Units 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 Variance

    Static- Static-Actual budget budget

    Product results amount variance

    Grammar $216,000 $222,950 $ 6,950 U

    Translation 39,600 36,260 3,340 F

    Composition 56,700 66,150 9,450 UTotal $312,300 $325,360 $13,060 U

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    Flexible-Budget Variance

    Actualcontribution Unit Actual

    Product margin/unit volume results

    Grammar $75 2,880 $216,000

    Translation $40 990 $ 39,600

    Composition $90 630 $ 56,700

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    Flexible-Budget Variance

    Budgeted Actualcontribution unit Flexible

    Product margin/unit volume budgetGrammar $70 2,880 $201,600

    Translation $37 990 $ 36,630

    Composition $90 630 $ 56,700

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    Flexible-Budget Variance

    Flexible- Flexible-Actual budget budget

    Product results amount varianceGrammar $216,000 $201,600 $14,400 F

    Translation $39,600 $ 36,630 $ 2,970 F

    Composition $56,700 $ 56,700 0Total flexible-budget variance $17,370 F

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    Sales-Volume Variance

    Budgetedcontribution

    Product Actual Budget marginGrammar (2,8803,185) $70 = $21,350 U

    Translation (990 980) $37 = 370 F

    Composition (630 735) $90 = 9,450 UTotal sales-volume variance $30,430 U

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    Sales-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 Variance

    Grammar: 4,500(0.640.65) $70 = $3,150 U

    Translation: 4,500(0.220.20) $37 = $3,330 F

    Composition: 4,500(0.140.15) $90 = $4,050 U

    Total sales-mix variance = $3,870 U

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    Sales-Quantity Variance

    Sales-quantity variance

    Actual units of all products soldBudgeted units of all products sold

    Budgeted sales-mix percentage

    Budgeted contribution margin per unit

    =

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    Sales-Quantity Variance

    Grammar:

    (4,5004,900) 0.65 $70 = $18,200 U

    Translation:

    (4,5004,900) 0.20 $37 = $ 2,960 U

    Composition:(4,5004,900) 0.15 $90 = $ 5,400 U

    Total sales-quantity variance = $26,560 U

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    Learning Objective 8

    Provide additional information

    about the sales-quantity varianceby calculating the market-share

    variance and themarket-size variance.

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    Market-Share Variance Example

    Assume that English Languages Institute derives

    its total unit sales budget for 2003 from amanagement estimate of a 20% market share

    and a total industry sales forecast by Desert

    Services of 24,500 units in the region.

    In 2003, Desert Services reported actual

    industry sales of 28,125 units.

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    Market-Share Variance Example

    What is Englishs 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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    Market-Share Variance Example

    What is the market-share variance?

    Actual market size in units

    Actual market share

    Budgeted market share

    Budgeted contribution margin per

    composite unit for budgeted mix

    =

    28,125(0.160.20) $66.40 = $74,700 U

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    Market-Share Variance Example

    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 Example

    Market-size variance

    Actual market size in units

    Budgeted market size in units

    Budgeted market share

    Budgeted contribution margin per

    composite unit for budgeted mix

    =

    (28,12524,500) 0.20 $66.40 = $48,140 F

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    Market-Size Variance Example

    Actual Market Size Budgeted Market Share

    Budgeted Average Contribution Margin Per Unit

    28,125 0.20 $66.40 = $373,500Static 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 Variances

    Static-Budget Variance

    13,060 U

    Level 1

    Level 2

    Flexible-Budget

    Variance$17,370 F

    Sales-Volume

    Variance$30,430 U

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    Summary of Variances

    Sales-Volume Variance

    $30,430 U

    Level 2

    Level 3

    Sales-Mix

    Variance$3,870 U

    Sales-Quantity

    Variance$26,560 U

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    Summary of Variances

    Sales-Quantity Variance

    $26,560 U

    Level 3

    Level 4

    Market-Share

    Variance$74,700 U

    Market-Size

    Variance$48,140 F

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    End of Chapter 14