PowerPoint Chapter 14

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 purposesfor allocating costs to

cost objects.


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



Guide cost-allocation decisionsusing appropriate criteria.


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.


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.


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?


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.



Discuss decisions facedwhen collecting costs in

indirect-cost pools.


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)



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.



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



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?



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



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?



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.



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



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.



Canton Division

Finishingdirect costs:

$900,000

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



Canton Division

Maintenancedirect costs:

$300,000

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



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 company’srevenues can differ across

customers purchasingthe same product.


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.



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?



1. The volume of programs purchased

2. The magnitude of price discounting


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



Customer A Customer BNumber of:Purchase orders 7 2Batches 7 2What is the cost of servicing each customer?



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.



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



Apply the concept of costhierarchy to customer costing.


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.


Cost Hierarchy1. Enterprise-related activities2. Market-related activities 3. Channel-related activities4. Customer-related activities5. Order-related activities6. Parts-related activities7. Direct materials



Discuss why customer-profitabilitydiffers across customers.


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


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 informationabout the sales-volume variance bycalculating the sales-mix varianceand the sales-quantity variance.


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



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




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.




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 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


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



Budgeted Actual contribution unit Flexible

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



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


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


Sales-Mix Variance

Sales-mix varianceActual 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 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


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

=××


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



Provide additional informationabout the sales-quantity varianceby calculating the market-share

variance and themarket-size variance.


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.



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



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



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


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


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


Summary of Variances

Static-Budget Variance13,060 ULevel 1

Level 2Flexible-Budget

Variance$17,370 F

Sales-VolumeVariance

$30,430 U



Sales-Volume Variance$30,430 ULevel 2

Level 3Sales-MixVariance$3,870 U

Sales-QuantityVariance

$26,560 U



Sales-Quantity Variance$26,560 ULevel 3

Level 4Market-Share

Variance$74,700 U

Market-SizeVariance$48,140 F


End of Chapter 14

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