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14 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation, Customer-Profitability Analysis, and
Sales-Variance Analysis
Chapter 14
14 - 2©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 1
Identify four purposesfor allocating costs to
cost objects.
14 - 3©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Purposes of Cost Allocation
1. To provide information for economic decisions2. To motivate managers and other employees3. To justify costs or compute reimbursement4. To measure income and assets for reporting
to external parties
14 - 4©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 2
Guide cost-allocation decisionsusing appropriate criteria.
14 - 5©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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 thebeneficiaries of the outputs of the cost object.
14 - 6©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Criteria to GuideCost-Allocation Decisions
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 proportionto the cost object’s ability to bear them.
14 - 7©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Role 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?
14 - 8©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Role 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.
14 - 9©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 3
Discuss decisions facedwhen collecting costs in
indirect-cost pools.
14 - 10©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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)
14 - 11©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
Corporate costs:Treasury $ 600,000Human resources $1,200,000Administration $4,800,000Treasury cost is interest to finance
equipment acquisition of $4,000,000in Canton and $2,000,000 in Dayton.
14 - 12©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
Division costs: Canton DaytonDirect costs $2,200,000 $4,000,000Indirect costs 1,980,000 2,500,000Total $4,180,000 $6,500,000
14 - 13©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
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?
14 - 14©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
Treasury costs: $600,000Canton Division:
$600,000 × ($4,000,000 ÷ $6,000,000) = $400,000Dayton Division:
$600,000 × ($2,000,000 ÷ $6,000,000) = $200,000
14 - 15©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
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?
14 - 16©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting 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)= $720,000
Smith does not allocate corporateadministration costs to the divisions.
14 - 17©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
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
14 - 18©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
77
Toledo Cleveland
Akron
Canton
Columbus
Cincinnati
Dayton
Grea t Miam iRive r
MuskingumRiver
OhioRive r
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.
14 - 19©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
Canton Division
Finishingdirect costs:
$900,000
Assembly direct costs $1,300,000Corporate costs 400,000Total costs $1,700,000
14 - 20©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting Systems Example
Canton Division
Maintenancedirect costs:
$300,000
Human Resources direct costs: $1,680,000Corporate costs: 480,000Total costs $2,160,000
14 - 21©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Allocation andCosting 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
14 - 22©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 4
Discuss why a company’srevenues can differ across
customers purchasingthe same product.
14 - 23©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer 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.
14 - 24©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer RevenueAnalysis Example
Customer A B
Programs sold 140 60List selling price $185 $185Invoice price $175 $180Total revenues $24,500 $10,800What explanation(s) can be given for
these revenue differences?
14 - 25©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer RevenueAnalysis Example
1. The volume of programs purchased
2. The magnitude of price discounting
14 - 26©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer 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
14 - 27©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer Cost Analysis Example
Customer A Customer BNumber of:Purchase orders 7 2Batches 7 2What is the cost of servicing each customer?
14 - 28©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer Cost Analysis Example
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.
14 - 29©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer Cost Analysis Example
Customer B:Ordering: 2 × $80/order = $160Setup: 2 × $100/batch = 200Total $360
14 - 30©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 5
Apply the concept of costhierarchy to customer costing.
14 - 31©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost 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.
14 - 32©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Hierarchy1. Enterprise-related activities2. Market-related activities 3. Channel-related activities4. Customer-related activities5. Order-related activities6. Parts-related activities7. Direct materials
14 - 33©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 6
Discuss why customer-profitabilitydiffers across customers.
14 - 34©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer-Profitability Profiles
Which customer is more profitable, A or B?A B
Revenues $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
14 - 35©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Customer-Profitability Profiles
Customer A seems to be more profitable.However, customer B has a higher gross
profit 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).
14 - 36©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 7
Provide additional informationabout the sales-volume variance bycalculating the sales-mix varianceand the sales-quantity variance.
14 - 37©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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
14 - 38©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-VolumeVariance Components
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
14 - 39©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-VolumeVariance Components
Product Grammar Translation Composition
Selling $/unit $255 $85 $185Variable cost 180 45 95Cont. margin
per unit $ 75 $40 $ 90
The following are the actual results forEnglish Languages for the year 2003.
14 - 40©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-VolumeVariance Components
Product Grammar Translation Composition
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
14 - 41©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Static-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
14 - 42©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Flexible-Budget Variance
Actual contribution Unit Actual
Product margin/unit volume resultsGrammar $75 2,880 $216,000Translation $40 990 $ 39,600Composition $90 630 $ 56,700
14 - 43©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Flexible-Budget Variance
Budgeted Actual contribution unit Flexible
Product margin/unit volume budgetGrammar $70 2,880 $201,600Translation $37 990 $ 36,630Composition $90 630 $ 56,700
14 - 44©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Flexible-Budget Variance
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
14 - 45©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-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
14 - 46©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-Mix Variance
Sales-mix varianceActual units of all products sold
Actual sales-mix percentage– Budgeted sales-mix percentage
Budgeted contribution margin per unit
=××
14 - 47©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-Mix Variance
Grammar: 4,500(0.64 – 0.65) × $70 = $3,150 UTranslation: 4,500(0.22 – 0.20) × $37 = $3,330 FComposition: 4,500(0.14 – 0.15) × $90 = $4,050 UTotal sales-mix variance = $3,870 U
14 - 48©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-Quantity Variance
Sales-quantity varianceActual units of all products sold
– Budgeted units of all products soldBudgeted sales-mix percentage
Budgeted contribution margin per unit
=××
14 - 49©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Sales-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
14 - 50©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 8
Provide additional informationabout the sales-quantity varianceby calculating the market-share
variance and themarket-size variance.
14 - 51©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-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 actual
industry sales of 28,125 units.
14 - 52©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Share Variance Example
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
14 - 53©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Share Variance Example
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
14 - 54©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Share Variance Example
Actual Market Size × Actual Market Share× Budgeted Average Contribution Margin Per Unit
28,125 × 0.16 × $66.40 = $298,800Actual Market Size × Budgeted Market Share
× Budgeted Average Contribution Margin Per Unit28,125 × 0.20 × $66.40 = $373,500$373,500 – $298,800 = $74,700 U
14 - 55©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Size Variance Example
Market-size varianceActual market size in units
– Budgeted market size in unitsBudgeted market share
Budgeted contribution margin percomposite unit for budgeted mix
=××
(28,125 – 24,500) × 0.20 × $66.40 = $48,140 F
14 - 56©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Size Variance ExampleActual Market Size × Budgeted Market Share
× Budgeted Average Contribution Margin Per Unit28,125 × 0.20 × $66.40 = $373,500Static Budget: Budgeted Market Size
× Budgeted market share× Budgeted Average Contribution Margin Per Unit
24,500 × 0.20 × $66.40 = $325,360$373,500 – $325,360 = $48,140 F
14 - 57©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Summary of Variances
Static-Budget Variance13,060 ULevel 1
Level 2Flexible-Budget
Variance$17,370 F
Sales-VolumeVariance
$30,430 U
14 - 58©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Summary of Variances
Sales-Volume Variance$30,430 ULevel 2
Level 3Sales-MixVariance$3,870 U
Sales-QuantityVariance
$26,560 U
14 - 59©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Summary of Variances
Sales-Quantity Variance$26,560 ULevel 3
Level 4Market-Share
Variance$74,700 U
Market-SizeVariance$48,140 F