Cost Allocation, Customer-Profitability Analysis, and Sales-Variance Analysis

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
Learning Objective 1
Identify four purposes
for allocating costs to
cost objects.
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 reporting
to external parties
Guide cost-allocation decisions
using appropriate criteria.
Criteria to Guide
Cost-Allocation Decisions
Cause-and-effect:
Using this criterion, managers identify the
variable or variables that cause resources
to be consumed.
Benefits-received:
Using this criterion, managers identify the
beneficiaries of the outputs of the cost object.
Criteria to Guide
Cost-Allocation Decisions
Fairness 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.
Role of Dominant Criteria
The cause-and-effect
and the benefits-
received criteria
guide most
decisions related
to cost allocations.
Fairness and ability
to bear are less
frequently used.
Why?
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.
Discuss decisions faced
when collecting costs in
indirect-cost pools.
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)
Cost Allocation and
Corporate costs:
Treasury $ 600,000
Human resources $1,200,000
Administration $4,800,000
Treasury cost is interest to finance
equipment acquisition of $4,000,000
in Canton and $2,000,000 in Dayton.
Cost Allocation and
Division costs: Canton Dayton
Direct costs $2,200,000 $4,000,000
Indirect costs 1,980,000 2,500,000
Total $4,180,000 $6,500,000
Cost Allocation and
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?
Cost Allocation and
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
Cost Allocation and
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?
Cost Allocation and
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 corporate
administration costs to the divisions.
Cost Allocation and
Canton Dayton
Treasury costs:
$600,000 (2/3 and 1/3) $400,000 $200,000
Human resources costs:
$1,200,000 40% and 60% 480,000 720,000
Total allocated to divisions $880,000 $920,000
Cost Allocation and
77
Toledo
Cleveland
Akron
Canton
Columbus
Cincinnati
Dayton
Great Miami
River
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 the
divisions to the Dept.
of Human Resources.
Cost Allocation and
Canton Division
Finishing
direct costs:
$900,000
Assembly
direct costs $1,300,000
Corporate costs 400,000
Total costs $1,700,000
Cost Allocation and
Canton Division
Maintenance
direct costs:
$300,000
Human Resources
direct costs: $1,680,000
Corporate costs: 480,000
Total costs $2,160,000
Cost Allocation and
Canton Division
$5,060,000
Assembly Dept.
$1,700,000
Finishing Dept.
$900,000
Maintenance Dept.
$300,000
Human Resources Dept.
$2,160,000
Discuss why a companys
revenues can differ across
customers purchasing
the same product.
Customer Revenue
Analysis Example
During the first six months of 2003,
English Languages Institute expanded
its market and sold 200 composition
programs to two new customers in Mexico.
Customer A is in Tijuana and
customer B is in Guadalajara.
Customer Revenue
Analysis Example
Customer
A B
Programs sold 140 60
List selling price $185 $185
Invoice price $175 $180
Total revenues $24,500 $10,800
What explanation(s) can be given for
these revenue differences?
Customer Revenue
Analysis Example
1. The volume of programs purchased
2. The magnitude of price discounting
Customer Cost Analysis Example
Assume that English Languages Institute
has an activity-based costing system that
focuses on customers rather than products.
Activity Area Cost Driver and Rate
Order taking $ 80 per purchase
Order set up $100 per batch
Customer A Customer B
Number of:
Purchase orders 7 2
Batches 7 2
What is the cost of servicing each customer?
Customer A:
Ordering: 7 $80/order = $ 560
Set-up: 7 $100/batch = 700
Total $1,260
English can use this information to persuade
this customer to reduce usage of the
ordering and setup cost drivers.
Customer B:
Ordering: 2 $80/order = $160
Setup: 2 $100/batch = 200
Total $360
Apply the concept of cost
hierarchy to customer costing.
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.
Cost 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
Discuss why customer-profitability
differs across customers.
Customer-Profitability Profiles
Which customer is more profitable, A or B?
A B
Revenues $24,500 $10,800
Cost of good sold ($95 per unit) 13,300 5,700
Contribution margin $11,200 $ 5,100
Other expenses 1,260 360
Operating income $ 9,940 $ 4,740
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).
Provide additional information
about the sales-volume variance by
calculating the sales-mix variance
and the sales-quantity variance.
Sales-Volume
Variance Components
The following information relates to English
Languages Institute budget for the year 2003.
Product Grammar Trans. Comp.
Selling price per unit $259 $87 $185
Variable cost 189 50 95
Contribution margin per unit $ 70 $37 $ 90
Sales-Volume
Variance 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
Sales-Volume
Variance Components
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.
Sales-Volume
Variance Components
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
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 U
Total $312,300 $325,360 $13,060 U
Flexible-Budget Variance
Actual
contribution Unit Actual
Product margin/unit volume results
Grammar $75 2,880 $216,000
Translation $40 990 $ 39,600
Composition $90 630 $ 56,700
Budgeted Actual
contribution unit Flexible
Product margin/unit volume budget
Grammar $70 2,880 $201,600
Translation $37 990 $ 36,630
Composition $90 630 $ 56,700
Flexible- Flexible-
Actual budget budget
Product results amount variance
Grammar $216,000 $201,600 $14,400 F
Translation $39,600 $ 36,630 $ 2,970 F
Composition $56,700 $ 56,700 0
Total flexible-budget variance $17,370 F
Sales-Volume Variance
Budgeted
contribution
Product Actual Budget margin
Grammar (2,880 3,185) $70 = $21,350 U
Translation (990 980) $37 = 370 F
Composition (630 735) $90 = 9,450 U
Total sales-volume variance $30,430 U
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
=

Sales-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
Sales-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
=

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
Provide additional information
about the sales-quantity variance
by calculating the market-share
variance and the
market-size variance.
Market-Share Variance Example
Assume that English Languages Institute derives
its total unit sales budget for 2003 from a
management 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.
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 average
contribution margin per unit?
$325,360 4,900 = $66.40
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(0.16 0.20) $66.40 = $74,700 U
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
28,125 0.20 $66.40 = $373,500
$373,500 $298,800 = $74,700 U
Market-Size Variance Example
Market-size variance
Actual market size in units
Budgeted market size in units
Budgeted contribution margin per
composite unit for budgeted mix
=

(28,125 24,500) 0.20 $66.40 = $48,140 F
Market-Size Variance Example
Actual Market Size Budgeted Market Share
28,125 0.20 $66.40 = $373,500
Static Budget: Budgeted Market Size
24,500 0.20 $66.40 = $325,360
$373,500 $325,360 = $48,140 F
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
Sales-Volume Variance
$30,430 U
Level 2
Level 3
Sales-Mix
Variance
$3,870 U
Sales-Quantity
Variance
$26,560 U
$26,560 U
Level 3
Level 4
Market-Share
Variance
$74,700 U
Market-Size
Variance
$48,140 F
End of Chapter 14

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14 - 1 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Allocation, Customer-

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