Chapter
15
Business prophets tell us what should happen
– but business profits tell us what did happen.
Earl Wilson

Comparison
Factors
Bases for computing costs
Marketing Cost
Analysis
Marketing unit: territory, customer group, order size, as well as product
More complex
Production Cost
Accounting
Unit of product
Relatively simple
Source of cost incurred
Cost-volume relationship
Salespeople in the field
Less exact
Volume is a function of cost V=f( C )
Difficult to measure
Machines and closely supervised workers
More precise
Cost is a function of volume C=f(V)
Relatively easy to measure

Net sales
Less cost of goods sold
Gross margin
Less operating expenses:
$27,000
18,900
8,100
Sales force travel
Supplies and telephone
Media space
Advertising salaries
Property taxes
Heat and light
Insurance
Administrative salaries
Other expenses
Total operating expenses
Net profit
372
178
870
218
120
168
84
930
120
6,300
$ 1,800

(showing allocation of ledger expense items to activity categories)
Activity Cost Categories
Personal Warehousing Order
Ledger expenses
Sales force travel
Supplies & telephone
Media space
Advertising salaries
Property taxes
Heat and light
Insurance
Administ. salaries
Other expenses
Totals
Totals
372,000
SellingAdvertising and ShippingProcessingAdministration
372,000
—
—
—
—
—
—
—
—
178,000
870,000
218,000
120,000
168,000
43,200 22,200
— 870,000
—
218,000
10,000 14,500
15,300 17,400
40,900 43,500
—
—
—
—
66,000
100,500
14,000
16,200
28,200
—
—
15,500
18,600
84,000 12,000 4,200
930,000 144,000 62,000
46,300 14,000
168,000 126,000
120,000 10,500 11,700 58,300 26,300
$6,300,000 3,847,000 1,220,000 480,000 240,000
7,500
430,000
13,200
513,000

Activity
Allocation basis
Total activity cost
No. of allocation units
Cost per allocation unit
Allocation of Activity Costs to Sales Regions,
Col Ski Co. 2002 (Fig. 15-4)
Personal
Selling
Warehousing Order
Advertising and Shipping Processing Administration
Allocation Scheme
Direct expense No. of pages No. of orders No. of invoice Equally among to each region of ads shipped lines regions
$3,847,000 $1,220,00 $480,000
—
—
$240,000 $513,000
61 pages 9,600 orders 120,000 lines 3 regions
$20,000/pg. $50 per order $2 per line $171,000/reg.
Region
Eastern
Midwestern
Western
Allocation of Costs units
—
21 pages 3,800 orders 39,500 lines cost $1,070,000 $420,000 $190,000 units — 11 pages 2,500 orders
$79,000
28,000 lines one
$171,000 one cost $747,000 $220,000 $125,000 units — 29 pages 3,300 orders
$56,000
52,500 lines cost $2,030,000 $580,000 $165,000
$171,000 one
$105,000 $171,000

Net sales
Less cost of goods sold
Gross margin
Less operating expenses:
Personal selling
Advertising
Warehousing/shipping
Order processing
Administration
Total operating expenses
Net profit (loss)
Net profit (loss) as percentage of sales
Total Eastern Midwestern Western
$27,000 $9,000 $4,500 $13,500
18,900 6,300
8,100 2,700
3,150
1,350
9,450
4,050
3,847 1,070
1,220
480
240
513
6.70%
420
190
79
171
6,300 1,930
$ 1,800 $ 770
8.60%
802
220
125
56
171
1,975
580
165
105
171
1,374 2,996
($24) $ 1,054
(0.53%) 7.80%

Method
Divide cost equally among territories or whatever market segments are being analyzed.
Allocate costs in proportion to sales volume obtained from each territory (or product or customer group).
Evaluation
Easy to do, but inaccurate and usually unfair to some market segments.
Underlying philosophy: apply cost burden where it can best be borne. That is, charge a high-volume market segment with a large share of the indirect cost. This method is simple and easy to do, but may be very inaccurate. Tells very little about a segment’
Allocate indirect costs in same proportion Again, easy to do but can be inaccurate and as the total direct costs. Thus if product A misleading. Falsely assumes a close accounted for 25 percent of the total direct costs, then A would also be relationship between direct and indirect expenses.
expenses.

Income and Expense Statement by Sales Region, Col Ski Co
2002, in $000, using contribution-margin approach (Fig. 15-7)
Net sales
Less cost of goods sold
Gross margin
Less direct operating expenses:
Personal selling
Advertising
Warehousing/shipping
Order processing
Total direct expenses
Contribution margin
Less indirect operating expenses:
Personal selling
Advertising
Warehousing/shipping
Order processing
Administration
Total indirect expenses
Net profit
Total Eastern M idwestern Western
$27,000 $9,000 $4,500 $13,500
18,900 6,300
8,100 2,700
3,150
1,350
9,450
4,050
3,082
732
160
845
254
64
130 43
4,104 1,206
$ 3,996 $1,494
765
488
320
110
513
$2,196
$1,800
595
127
42
1,642
351
54
30
794
57
2,104
$ 556 $1,946

Fig. 15-8 Ways to Increase Order Size and
Reduce Small Order Marketing Costs
•Ed ucate customers who buy from several different suppliers. Stress the advantages of purchasing from one supplier.
•For customers who purchase large total quantities in frequent small orders, stress the advantages of ordering once a month instead of once a week. Point out that the buyer eliminates all handling, billing, and accounting expenses connected with three of the four orders. Note further that the buyer writes only one check and one purchase order. In addition, stress that there will be only one bill to process and one shipment to put into inventory instead of three or four.
•Educate the sales force as well as customers. In fact, it may be necessary to change the compensation plan to discourage acceptance of smaller orders.
•Substitute direct mail or telephone selling for sales calls or unprofitable or small-order accounts; or continue to call on these accounts, but less frequently.
•Shift an account to a wholesaler or some other type of middleman rather than dealing directly, even by mail or telephone.
•Drop a mass-distribution policy and adopt a selective one. This new policy may actually increase sales because sales reps can spend more time with profitable accounts.
•Establish a minimum-order size.
•Establish a minimum charge or a service charge to combat small orders

Return on Assets Managed (ROAM)
Sales
Cost of goods sold
Gross margin
Salaries
Commission
Travel
District office expense
$ 10,000,000
7,000,000
3,000,000
150,000
850,000
150,000
400,000
Total direct expenses 150,000
Contribution margin $ 1,450,000
Accounts receivable 2,200,000
Inventories 2,000,000
Total assets $ 4,200,000
Profit on sales %
=
Contribution margin
Sales volume
=
1,450,000
10,000,000 x
100
=
14.5%
Asset turnover
=
Accounts receivable + Inventories
=
$ 4,200,000
=
2.38
ROAM = Profit on sales % x Asset turnover
=
10,000,000 4,200,000
= 14.5% x 2.38 = 34.5%