©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Chapter 14

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Identify four purposes for allocating costs to cost objects.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Guide cost-allocation decisions using appropriate criteria.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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. Why?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Discuss decisions faced when collecting costs in indirect-cost pools.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Smith Corporation manufactures clothes washers and dryers in two divisions: Clothes Washer Division in Canton (CWD) Clothes Dryer Division in Dayton (CDD)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Division costs: Canton Dayton Direct costs$2,200,000$4,000,000 Indirect costs 1,980,000 2,500,000 Total$4,180,000$6,500,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Canton Dayton Treasury costs: $600,000 ( 2/3 and 1/3) $400,000$200,000 Human resources costs: $1,200,000 40% and 60% 480, ,000 Total allocated to divisions$880,000$920,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Treasury costs are reallocated by the divisions to Assembly. Human resources costs are reallocated by the divisions to the Dept. of Human Resources.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Canton Division Finishing direct costs: $900,000 Assembly direct costs$1,300,000 Corporate costs 400,000 Total costs$1,700,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Canton Division Maintenance direct costs: $300,000 Human Resources direct costs:$1,680,000 Corporate costs: 480,000 Total costs$2,160,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Canton Division $5,060,000 Assembly Dept. $1,700,000 Finishing Dept. $900,000 Maintenance Dept. $300,000 Human Resources Dept. $2,160,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Discuss why a company’s revenues can differ across customers purchasing the same product.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Customer AB Programs sold 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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 1. The volume of programs purchased 2. The magnitude of price discounting

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Assume that English Languages Institute has an activity-based costing system that focuses on customers rather than products. Activity AreaCost Driver and Rate Order taking$ 80 per purchase Order set up$100 per batch

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Customer A Customer B Number of: Purchase orders 7 2 Batches 7 2 What is the cost of servicing each customer?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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 ordering and setup cost drivers.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Customer B: Ordering:2 × $80/order=$160 Setup:2 × $100/batch= 200 Total$360

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Apply the concept of cost hierarchy to customer costing.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Discuss why customer-profitability differs across customers.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Which customer is more profitable, A or B? A B Revenues$24,500$10,800 Cost of good sold ($95 per unit) 13,300 5,700 Contribution margin $11,200$ 5,100 Other expenses 1, Operating income$ 9,940$ 4,740

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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).

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Provide additional information about the sales-volume variance by calculating the sales-mix variance and the sales-quantity variance.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster The following information relates to English Languages Institute budget for the year Product Grammar Trans. Comp. Selling price per unit$259 $87$185 Variable cost Contribution margin per unit$ 70 $37$ 90

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster ProductGrammarTranslationComposition Cont. margin$70$37$90 × Units3, = Total$222,950$36,260$66,150 Sales mix65%20%15% Total budgeted contribution margin = $325,360

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster ProductGrammarTranslationComposition Selling $/unit$255$85$185 Variable cost Cont. margin per unit $ 75$40$ 90 The following are the actual results for English Languages for the year 2003.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster ProductGrammarTranslationComposition Cont. margin$75$40$90 × Units2, = Total$216,000$39,600$56,700 Sales mix64%22%14% Total actual contribution margin = $312,300

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Static- Static- Actual budget budget Product results amount variance Grammar$216,000$222,950$ 6,950 U Translation 39,600 36,260 3,340 F Composition 56,700 66,150 9,450 U Total$312,300$325,360$13,060 U

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Actual contribution Unit Actual Product margin/unit volume results Grammar$752,880$216,000 Translation$40 990$ 39,600 Composition$90 630$ 56,700

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted Actual contribution unit Flexible Product margin/unit volume budget Grammar$702,880$201,600 Translation$37 990$ 36,630 Composition$90 630$ 56,700

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Flexible-Flexible- Actual budget budget Product results amount variance Grammar$216,000$201,600$14,400 F Translation$39,600 $ 36,630$ 2,970 F Composition$56,700 $ 56,700 0 Total flexible-budget variance$17,370 F

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted contribution Product Actual Budget margin Grammar(2,880 – 3,185) × $70 =$21,350 U Translation (990 – 980) × $37 = 370 F Composition (630 – 735) × $90 = 9,450 U Total sales-volume variance$30,430 U

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sales-mix variance Actual units of all products sold Actual sales-mix percentage – Budgeted sales-mix percentage Budgeted contribution margin per unit = × ×

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sales-quantity variance Actual units of all products sold – Budgeted units of all products sold Budgeted sales-mix percentage Budgeted contribution margin per unit = × ×

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Provide additional information about the sales-quantity variance by calculating the market-share variance and the market-size variance.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Static-Budget Variance 13,060 U Level 1 Level 2 Flexible-Budget Variance $17,370 F Sales-Volume Variance $30,430 U

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sales-Volume Variance $30,430 U Level 2 Level 3 Sales-Mix Variance $3,870 U Sales-Quantity Variance $26,560 U

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sales-Quantity Variance $26,560 U Level 3 Level 4 Market-Share Variance $74,700 U Market-Size Variance $48,140 F

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster