Chris Adams, “Steelmakers Complain About Foreign Steel; They Import It Too,” The Wall Street Journal (March 1 and March 8). Scott McCartney, “Why Ticket Says Coach but Seat Is Up Front,” The Wall Street Journal (B1 September).
Absorption-Costing Approach to M easuring Profit
As a result, many of the concepts covered in this chapter are relevant to nonprofit economic entities. Non-profit firms are still interested in the relationship between income and expenditure, or inputs and outputs.
Preparing the Absorption-Costing Income Statement
Remember that the difference between revenue and cost of goods sold is gross profit (or gross margin). Now, gross profit is less useful and cannot be used as a sole measure of the long-term health of the firm.
Disadvantages of Absorption Costing
Exhibit 19-3 also shows the "Percent of Sales" column that is often associated with the absorption costing income statement. Firms that use absorption costing revenue as a measure of profitability may introduce rules on production.
Variable-Costing Approach to M easuring Profit
In September, inventory increased and absorption costing operating income is higher than variable costs. In this case, when inventory decreases (or production is less than sales), variable costing operating income is greater than absorption costing operating income.
Profitability of Segments
Profit by Product Line
Using Variable Costing to M easure Segment Profit
Using Activity-Based Costing to M easure Segment Profit
We can now redesign a product line's income statement using activity-based costing information. The value of the income statement by activity is that it reminds management that costs cannot be simply separated into fixed and variable components based on units alone. However, the activity-based approach shows the complexity of the production process and reminds managers that reducing electricity costs can only be achieved by reducing the use of machinery (perhaps by using more efficient machinery).
It should be pointed out that a purely activity-based costing approach is not acceptable for external financial reporting.
Divisional Profit
Declining profits, combined with the knowledge that customers do not like crumpled faxes, may lead management to discontinue the basic fax machine, even with the positive profits it shows.
Customer Profitability
Originating and Keeping Customers
The first class consists of clients with suitable profit levels and potential for increased trading volume. The second class consists of customers who are profitable in their current mix of services but are unlikely to respond to improvement efforts. The third class of customers includes those customers whose revenues do not fully cover costs, but whose marginal revenues contribute to fixed overheads and who have the potential for improvement.
Another alternative to BZW is to change the mix of services provided to a customer by changing the seniority of the staff.
Overall Profit
Now it can assess not only the profitability of each customer, but also the reasons for it. For example, High Flight is a company engaged in three services: flight training, short-haul flights (basically a courier service for regional banks) and aircraft leasing. But the owner of High Flight realized that such an allocation would divert attention from the underlying question: Should all three services be offered.
Ultimately, High Flight performed a modified profitability analysis of each service and determined that flight training was likely a money loser.
Analysis of Profit-Related Variances
The same aircraft were used for each, so the allocation of aircraft depreciation to the three services seems reasonable. They kept all three because they realized that pilots prefer to rent planes from the place where they received flight training. The link between flight training and aircraft leasing therefore meant that the company had to retain both or neither.
Sales Price and Price Volume Variances
For example, an unfavorable sales price variance may be accompanied by a favorable price volume variance because the lower price increased the quantity sold.
Contribution M argin Variance
Contribution M argin Volume Variance
The contribution margin variance therefore provides management with information about profit gained or lost due to changes in sales volume. Contribution Margin Volume Variance (Actual Quantity Sold Forecasted Quantity Sold) Planned Average Contribution Margin Per Unit The projected average contribution margin per unit is the total planned contribution margin divided by the planned total number of units of all products to be sold. The unfavorable difference in the volume of contributions is clearly the result of total sales of fewer units than planned.
Sales M ix Variance
M arket Share and M arket Size Variances
The market share variance is the difference between the actual market share percentage and the budgeted market share, multiplied by the actual industry turnover in units times the budgeted average contribution margin per unit. The market size variance is the difference between actual and budgeted industry sales in units, multiplied by the budgeted market share percentage times the budgeted average contribution margin per unit. Difference in market share [(actual market share percentage, budgeted market share percentage) (actual industry turnover in units)].
This means that the company's contribution margin would have increased by this amount if the actual market share percentage was equal to the budgeted market share percentage.
The Product Life Cycle
Unit-level costs are highest in the introductory phase because new materials are sought in small order quantities. In the growth phase, costs at the batch level should decrease as the positive impact of learning occurs. Facility-level costs may or may not be affected unless the product requires a new facility or equipment; then they are highest in the introductory phase.
Exhibit 19-15, on the next page, depicts the general direction of costs in the ABC categories throughout the product life cycle.
Limitations of Profit M easurement
The quote at the beginning of this section is taken from an article about The Anderson Group, a small network installation company in Akron, Ohio. Their jobs, promotions, and bonuses may depend on annual profits, and this dependency can influence their behavior in expected and unexpected ways. People's desire to avoid losses and their tendency to take a short-term perspective can influence the likelihood of unethical behavior.
Workers essentially look for companies to "put their money where their mouth is." If raises, promotions, and bonuses are given solely on the basis of profit, employees will work to increase profits.
P RICING
Required
LU TION
Yes, the Mixalot was profitable over the five-year cycle, even after deducting design and development costs. This makes sense considering that the Mixalot wasn't a radically new product, i.e. there were other devices on the market that could do what the Mixalot could do. Melcher Company had to get the Mixalot into real kitchens to build demand.
Finally, by the fifth year, the Mixalot is in the declining phase of the product life cycle.
A BSORPTION AND V ARIABLE C OSTING , S EGMENTED I NCOME S TATEMENTS
Calculate the unit cost of coin purses and key rings using the variable costing method. Note that the only difference between the two unit costs is the allocation of the fixed overhead costs. Finally, note that variable non-manufacturing costs are not part of the unit costs under variable costs.
Since variable costing recognized all of the current period's fixed overhead as an expense, variable costing revenue should be $1,000 lower than absorption costing revenue, as is.
E LASTICITY OF D EMAND AND M ARKET S TRUCTURE
D EMAND C URVE AND C HARACTERISTICS OF M ARKET S TRUCTURE
B ASICS OF D EMAND , L IFE -C YCLE P RICING
In fact, he believes he should be able to charge $75 per hour, given his high GPA and the fact that he is up to date on current accounting issues.
M ARKUP ON C OST , C OST -B ASED P RICING
M ARKUP ON C OST
A BSORPTION AND V ARIABLE C OSTING WITH
O VER - AND U NDERAPPLIED O VERHEAD
The company used an expected actual activity level of 24,000 direct labor hours to calculate predetermined overhead costs.
V ARIABLE C OSTING , A BSORPTION C OSTING
C OST -B ASED P RICING , T ARGET P RICING
C OST -B ASED P RICING
Calculate the minimum price per blanket that Marcus Fibers could offer without reducing the company's operating income. Based on the full cost criteria and the specified maximum allowable return, calculate Marcus Fibers' bid price per blanket. Without prejudice to your response to Requirement 2, you assume that the price per blanket that Marcus Fibers calculated based on the specified cost-plus criteria exceeds the maximum allowable bid of $25 per blanket.
Discuss the factors that Marcus Fibers should consider before deciding whether to submit a bid at the maximum acceptable price of $25 per blanket.
L IFE -C YCLE P RICING , S ALES P RICE
AND P RICE V OLUME V ARIANCES
P RICING S TRATEGY , S ALES V ARIANCES
P RICE D ISCRIMINATION AND THE R OBINSON -P ATMAN A CT
P RICE D ISCRIMINATION
U NIT C OSTS , I NVENTORY V ALUATION , V ARIABLE AND A BSORPTION C OSTING
What is the dollar amount that would be used to report the cost of finished goods inventory to external parties.
I NCOME S TATEMENTS , V ARIABLE
AND A BSORPTION C OSTING
I NCOME S TATEMENTS AND F IRM P ERFORMANCE : V ARIABLE AND A BSORPTION C OSTING
A BSORPTION - AND V ARIABLE - C OSTING I NCOME S TATEMENTS
For the year ended December 31, 2007, prepare the revised income statement for Portland Optics, Inc., using the variable-cost method.
C ONTRIBUTION M ARGIN V ARIANCE , C ONTRIBUTION
M ARGIN V OLUME V ARIANCE , S ALES M IX V ARIANCE
M ARGIN V OLUME V ARIANCE , M ARKET S HARE V ARIANCE , M ARKET S IZE V ARIANCE
S EGMENTED I NCOME S TATEMENTS , A NALYSIS OF P ROPOSALS TO I MPROVE P ROFITS
Assuming Paula's proposals are sound, Madge Shannon should be happy with the prospects for the Party Supplies department. Prepare a segmented income statement for the next quarter that reflects the implementation of Paula's proposals. Suppose that the Cookware Division's sales will increase by 5 percent in the coming quarter and that the same cost ratios will remain.
Suppose everything materializes as Paula predicted, except for the 10 percent increase in sales—there was no change in sales revenue.
I MPACT OF I NVENTORY C HANGES ON A BSORPTION - C OSTING I NCOME , D IVISIONAL P ROFITABILITY
According to its marketing staff, sales should increase by 10 percent if the right advertising is done—and done quickly. After all, she was the one who had chosen Paula and had great faith in Paula's judgment and abilities. What if variable costs are reduced by 40 percent instead of 30 percent with no change in sales.
Instead of seeing a significant increase in income for the third year, she saw a slight decrease.
E THICAL I SSUES , A BSORPTION C OSTING , P ERFORMANCE M EASUREMENT
If you were the vice president of Dana's company, which income statement (variable costing or absorption costing) would you prefer to use to evaluate Dana's performance.
S EGMENTED I NCOME S TATEMENTS , A DDING
AND D ROPPING P RODUCT L INES
O PERATING I NCOME FOR S EGMENTS
Jerrell, Inc., had corporate administrative expenses of $250,000; these were not assigned to departments.
P RODUCT P ROFITABILITY
C USTOMER P ROFITABILITY , L IFE -C YCLE R EVENUE
C USTOMER P ROFITABILITY
S EGMENTED R EPORTING AND V ARIANCES
After reviewing the 2007 budget, new CEO Joe Kelly decided to close the mid-range lighting fixture product line by the end of the first quarter and use available manufacturing capacity to grow the remaining two product lines. Increases above that level and increasing sales of luxury lighting fixtures would require increased advertising expenditures to increase consumer awareness of PWC as an electronics and luxury lighting fixture company. Joe advised the divisions that the original product line operating income targets should be met for bonus purposes, but he did allow the Lighting Fixtures Division to combine the operating income targets for both product lines for bonus purposes.
The controller of the Lighting Fixtures division, who expects a similar bonus plan for 2008, is considering deferring some revenues to the following year on the pretext that sales have not yet been finalized and that appropriate expenses will be incurred in the current year will be in the Lighting Fixtures division. first quarter of 2008.
C OLLABORATIVE L EARNING E XERCISE
Customers who purchase a videotape and mail in a receipt (with the original box office receipt) will receive $5 by return mail. Past experience shows that only 25 percent of customers who are entitled to this discount will take advantage of the discount. Tell which stage of the wellness video tape product life cycle applies to each quarter.
List the stages of the product life cycle and find two products not mentioned in the text that fit into each stage.
C YBER R ESEARCH C ASE
