Cost Accounting, Chapter 14 11ch14

(1)

Cost Allocation,

Customer-Profitability Analysis, and

Sales-Variance Analysis

Cost Allocation,

Customer-Profitability Analysis, and

Sales-Variance Analysis

(2)

Learning Objective 1

Identify four purposes

for allocating costs to

(3)

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

(4)

Learning Objective 2

(5)

Criteria to Guide

Cost-Allocation Decisions

Criteria to Guide

Cause-and-effect:

Using this criterion, managers identify the variable or variables that cause resources

to be consumed.

Benefits-received:

(6)

Criteria to Guide

Cost-Allocation Decisions

Criteria to Guide

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:

(7)

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.

(8)

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

(9)

Learning Objective 3

Discuss decisions faced

when collecting costs in

(10)

Cost Allocation and

Costing Systems Example

Cost Allocation and

Smith Corporation manufactures clothes washers and dryers in two divisions:

(11)

Cost Allocation and

Costing Systems Example

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

(12)

Cost Allocation and

(13)

Cost Allocation and

Costing Systems Example

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.

(14)

Cost Allocation and

Costing Systems Example

Cost Allocation and

Treasury costs: $600,000 Canton Division:

$600,000 × ($4,000,000 ÷ $6,000,000) = $400,000 Dayton Division:

(15)

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

(16)

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

(17)

Cost Allocation and

Canton Dayton Treasury costs:

$600,000 (2/3 and 1/3) $400,000 $200,000

Human resources costs:

(18)

Cost Allocation and

7 7

T o l e d o C l e v e l a n d

A k r o n

C a n t o n

C o l u m b u s

C i n c i n n a t i D a y t o n

G re a t Mia m i Rive r Musking um Rive r O hio Rive r Ohio Rive r

O H I O

7 0 7 5 8 0 9 0 9 0 7 1 7 6

Treasury costs are reallocated by the divisions to Assembly.

(19)

Cost Allocation and

Canton Division

Finishing direct costs:

$900,000 Assembly

(20)

Cost Allocation and

Canton Division

Maintenance direct costs:

$300,000 Human Resources

(21)

Cost Allocation and

Canton Division $5,060,000 Assembly Dept.

$1,700,000

Finishing Dept. $900,000

(22)

Learning Objective 4

Discuss why a company’s

revenues can differ across

(23)

Customer Revenue

Analysis Example

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

(24)

Customer Revenue

Analysis Example

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

(25)

Customer Revenue

Analysis Example

Customer Revenue

Analysis Example

1. The volume of programs purchased

(26)

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

(27)

Customer A Customer B Number of:

Purchase orders 7 2

Batches 7 2

(28)

Customer Cost Analysis Example

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

(29)

Customer B:

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

(30)

Learning Objective 5

Apply the concept of cost

(31)

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

(32)

Cost Hierarchy

1. Enterprise-related activities 2. Market-related activities 3. Channel-related activities 4. Customer-related activities 5. Order-related activities

(33)

Learning Objective 6

Discuss why customer-profitability

(34)

Customer-Profitability Profiles

Which customer is more profitable, A or B? A B

(35)

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).

(36)

Learning Objective 7

Provide additional information

about the sales-volume variance by

calculating the sales-mix variance

(37)

Sales-Volume

Variance Components

Sales-Volume

Variance Components

The following information relates to English Languages Institute budget for the year 2003.

(38)

Sales-Volume

Variance Components

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%

(39)

Sales-Volume

Variance Components

Sales-Volume

Variance Components

Product Grammar Translation Composition Selling $/unit $255 $85 $185

Variable cost 180 45 95 Cont. margin

$ 75 $40 $ 90 The following are the actual results for

(40)

Sales-Volume

Variance Components

Sales-Volume

Variance 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%

(41)

Static-Budget Variance

(42)

Flexible-Budget Variance

Actual

(43)

Flexible-Budget Variance

Budgeted Actual

(44)

(45)

Sales-Volume Variance

Budgeted contribution

Product Actual Budget margin

(46)

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

(47)

Sales-Mix Variance

(48)

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

(49)

Grammar:

(4,500 – 4,900) × 0.65 × $70 = $18,200 U Translation:

(4,500 – 4,900) × 0.20 × $37 = $ 2,960 U Composition:

(50)

Learning Objective 8

Provide additional information

about the sales-quantity variance

by calculating the market-share

variance and the

(51)

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

(52)

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 average contribution margin per unit?

(53)

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

=

×

(54)

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

(55)

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

=

×

(56)

Market-Size Variance Example

Actual Market Size × Budgeted Market Share

Static Budget: Budgeted Market Size

× Budgeted market share

(57)

Summary of Variances

Static-Budget Variance 13,060 U

Level 1

Level 2

$17,370 F

(58)

Summary of Variances

Sales-Volume Variance $30,430 U

Level 2

Level 3

Sales-Mix Variance $3,870 U

(59)

Sales-Quantity Variance $26,560 U

Level 3

Level 4

Market-Share Variance $74,700 U

(60)