14 - 1 cost allocation, customer- profitability analysis, and sales-variance analysis chapter 14
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14 - 1
Cost Allocation, Customer-Profitability Analysis, and
Sales-Variance Analysis
Cost Allocation, Customer-Profitability Analysis, and
Sales-Variance Analysis
Chapter 14
14 - 2
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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Learning Objective 2Learning Objective 2
Guide cost-allocation decisions
using appropriate criteria.
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Criteria to GuideCost-Allocation Decisions
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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Criteria to GuideCost-Allocation Decisions
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 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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Learning Objective 3Learning Objective 3
Discuss decisions faced
when collecting costs in
indirect-cost pools.
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Cost Allocation andCosting Systems Example
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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Cost Allocation andCosting Systems Example
Cost Allocation andCosting Systems Example
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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Cost Allocation andCosting Systems Example
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
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Cost Allocation andCosting Systems Example
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?
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Cost Allocation andCosting Systems Example
Cost Allocation andCosting 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 andCosting Systems Example
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?
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Cost Allocation andCosting Systems Example
Cost Allocation andCosting Systems Example
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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Cost Allocation andCosting Systems Example
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
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Cost Allocation andCosting Systems Example
Cost Allocation andCosting Systems Example
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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Cost Allocation andCosting Systems Example
Cost Allocation andCosting Systems Example
Canton Division
Finishingdirect costs:
$900,000
Assembly direct costs $1,300,000Corporate costs 400,000Total costs $1,700,000
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Cost Allocation andCosting Systems Example
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
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Cost Allocation andCosting Systems Example
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
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Learning Objective 4Learning Objective 4
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 RevenueAnalysis ExampleCustomer RevenueAnalysis Example
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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Customer RevenueAnalysis ExampleCustomer RevenueAnalysis Example
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 Cost Analysis ExampleCustomer Cost Analysis Example
Customer A Customer BNumber of:Purchase orders 7 2Batches 7 2
What is the cost of servicing each customer?
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Customer Cost Analysis ExampleCustomer 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.
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Customer Cost Analysis ExampleCustomer Cost Analysis Example
Customer B:Ordering: 2 × $80/order = $160Setup: 2 × $100/batch = 200Total $360
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Learning Objective 5Learning Objective 5
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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Learning Objective 6Learning Objective 6
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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Learning Objective 7Learning 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-VolumeVariance Components
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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Sales-VolumeVariance Components
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
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Sales-VolumeVariance Components
Sales-VolumeVariance Components
Product Grammar Translation Composition
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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Sales-VolumeVariance Components
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
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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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Flexible-Budget VarianceFlexible-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
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Flexible-Budget VarianceFlexible-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
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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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Learning Objective 8Learning Objective 8
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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Market-Share Variance ExampleMarket-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
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Market-Share Variance ExampleMarket-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
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Market-Share Variance ExampleMarket-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 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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Summary of VariancesSummary of Variances
Sales-Volume Variance$30,430 U
Level 2
Level 3Sales-MixVariance$3,870 U
Sales-QuantityVariance
$26,560 U
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Summary of VariancesSummary of Variances
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