Cost Allocation, CustomerProfitability Analysis, and
Sales-Variance Analysis
Chapter 14
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Learning Objective 1
Identify four purposes
for allocating costs to
cost objects.
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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
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Learning Objective 2
Guide cost-allocation decisions
using appropriate criteria.
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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.
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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 object’s ability to bear them.
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Role of Dominant Criteria
The cause-and-effect
and the benefitsreceived criteria
guide most
decisions related
to cost allocations.
Fairness and ability
to bear are less
frequently used.
Why?
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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.
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Learning Objective 3
Discuss decisions faced
when collecting costs in
indirect-cost pools.
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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)
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Cost Allocation and
Costing Systems Example
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.
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Cost Allocation and
Costing Systems Example
Division costs:
Direct costs
Indirect costs
Total
Canton
$2,200,000
1,980,000
$4,180,000
Dayton
$4,000,000
2,500,000
$6,500,000
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Cost Allocation and
Costing Systems Example
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?
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Cost Allocation and
Costing 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 and
Costing Systems Example
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?
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Cost Allocation and
Costing 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 corporate
administration costs to the divisions.
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Cost Allocation and
Costing Systems Example
Canton
Treasury costs:
$600,000 (2/3 and 1/3)
Human resources costs:
$1,200,000 40% and 60%
Total allocated to divisions
Dayton
$400,000 $200,000
480,000 720,000
$880,000 $920,000
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Cost Allocation and
Costing Systems Example
Treasury costs are
reallocated by the
divisions to Assembly.
Human resources costs
are reallocated by the
divisions to the Dept.
of Human Resources.
90
90
Toledo
Cleveland
80
76
Akron
Canton
71
75
OHIO
G re a t Mia m i
Rive r
Dayton
77
70
Columbus
O hio
Rive r
Musking um
Rive r
Cincinnati
O hio
Rive r
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Cost Allocation and
Costing Systems Example
Canton Division
Assembly
direct costs
$1,300,000
Corporate costs
400,000
Total costs
$1,700,000
Finishing
direct costs:
$900,000
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Cost Allocation and
Costing Systems Example
Canton Division
Human Resources
direct costs: $1,680,000
Corporate costs: 480,000
Total costs
$2,160,000
Maintenance
direct costs:
$300,000
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Cost Allocation and
Costing Systems Example
Assembly Dept.
$1,700,000
Finishing Dept.
$900,000
Canton Division
$5,060,000
Maintenance Dept.
$300,000
Human Resources Dept.
$2,160,000
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Learning Objective 4
Discuss why a company’s
revenues can differ across
customers purchasing
the same product.
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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.
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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?
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Customer Revenue
Analysis Example
1. The volume of programs purchased
2. The magnitude of price discounting
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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
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Customer Cost Analysis Example
Number of:
Purchase orders
Batches
Customer A
Customer B
7
7
2
2
What is the cost of servicing each customer?
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Customer Cost Analysis Example
Ordering:
Set-up:
Total
Customer A:
7 × $80/order = $ 560
7 × $100/batch =
700
$1,260
English can use this information to persuade
this customer to reduce usage of the
ordering and setup cost drivers.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Customer Cost Analysis Example
Ordering:
Setup:
Total
Customer B:
2 × $80/order = $160
2 × $100/batch = 200
$360
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Learning Objective 5
Apply the concept of cost
hierarchy to customer costing.
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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.
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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
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Learning Objective 6
Discuss why customer-profitability
differs across customers.
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Customer-Profitability Profiles
Which customer is more profitable, A or B?
A
Revenues
$24,500
Cost of good sold ($95 per unit) 13,300
Contribution margin
$11,200
Other expenses
1,260
Operating income
$ 9,940
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
B
$10,800
5,700
$ 5,100
360
$ 4,740
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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).
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Learning 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-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
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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
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Sales-Volume
Variance Components
The following are the actual results for
English Languages for the year 2003.
Product
Grammar
Translation Composition
Selling $/unit
$255
$85
$185
Variable cost
180
45
95
Cont. margin
per unit
$ 75
$40
$ 90
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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%
Total actual contribution margin = $312,300
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Static-Budget Variance
Product
Grammar
Translation
Composition
Total
Actual
results
$216,000
39,600
56,700
$312,300
StaticStaticbudget
budget
amount
variance
$222,950 $ 6,950 U
36,260
3,340 F
66,150
9,450 U
$325,360 $13,060 U
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Flexible-Budget Variance
Actual
contribution
Product
margin/unit
Grammar
$75
Translation
$40
Composition
$90
Unit
volume
2,880
990
630
Actual
results
$216,000
$ 39,600
$ 56,700
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Flexible-Budget Variance
Budgeted
contribution
Product
margin/unit
Grammar
$70
Translation
$37
Composition
$90
Actual
unit
volume
2,880
990
630
Flexible
budget
$201,600
$ 36,630
$ 56,700
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Flexible-Budget Variance
FlexibleActual
budget
Product
results
amount
Grammar
$216,000
$201,600
Translation $39,600
$ 36,630
Composition $56,700
$ 56,700
Total flexible-budget variance
Flexiblebudget
variance
$14,400 F
$ 2,970 F
0
$17,370 F
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Sales-Volume Variance
Product
Actual Budget
Grammar
(2,880 – 3,185)
Translation
(990 – 980)
Composition (630 – 735)
Total sales-volume variance
Budgeted
contribution
margin
× $70 = $21,350 U
× $37 =
370 F
× $90 =
9,450 U
$30,430 U
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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
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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
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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
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Sales-Quantity Variance
Grammar:
(4,500 – 4,900) × 0.65 × $70
Translation:
(4,500 – 4,900) × 0.20 × $37
Composition:
(4,500 – 4,900) × 0.15 × $90
Total sales-quantity variance
= $18,200 U
= $ 2,960 U
= $ 5,400 U
= $26,560 U
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Learning 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 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.
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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?
$325,360 ÷ 4,900 = $66.40
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Market-Share Variance Example
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
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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
× 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 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
(28,125 – 24,500) × 0.20 × $66.40 = $48,140 F
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Market-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 Unit
24,500 × 0.20 × $66.40 = $325,360
$373,500 – $325,360 = $48,140 F
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Summary of Variances
Level 1
Level 2
Static-Budget Variance
13,060 U
Flexible-Budget
Variance
$17,370 F
Sales-Volume
Variance
$30,430 U
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Summary of Variances
Level 2
Level 3
Sales-Volume Variance
$30,430 U
Sales-Mix
Variance
$3,870 U
Sales-Quantity
Variance
$26,560 U
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Summary of Variances
Level 3
Level 4
Sales-Quantity Variance
$26,560 U
Market-Share
Variance
$74,700 U
Market-Size
Variance
$48,140 F
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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End of Chapter 14
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