CHAPTER 14

COST ALLOCATION, CUSTOMER-PROFITABILITY

ANALYSIS, AND SALES-VARIANCE ANALYSIS

14-1 Disagree. Cost accounting data plays a key role in many management planning and
control decisions. The division president will be able to make better operating and strategy
decisions by being involved in key decisions about cost pools and cost allocation bases. Such an
understanding, for example, can help the division president evaluate the profitability of different
customers.

14-2 The salary of a plant security guard would be a direct cost when the cost object is the
security department of the plant. It would be an indirect cost when the cost object is a product.

14-3 Exhibit 14-1 outlines four purposes for allocating costs:

1. To provide information for economic decisions.
2. To motivate managers and employees.
3. To justify costs or compute reimbursement.
4. To measure income and assets for reporting to external parties.

14-4 Exhibit 14-2 lists four criteria used to guide cost allocation decisions:
1. Cause and effect.
2. Benefits received.
3. Fairness or equity.
4. Ability to bear.
The cause-and-effect criterion and the benefits-received criterion are the dominant criteria when
the purpose of the allocation is related to the economic decision purpose or the motivation
purpose.

14-5 Using the levels approach introduced in Chapter 7, the sales-volume variance is a Level
2 variance. By sequencing through Level 3 (sales-mix and sales-quantity variances) and then
Level 4 (market-size and market-share variances), managers can gain insight into the causes of a
specific sales-volume variance caused by changes in the mix and quantity of the products sold as
well as changes in market size and market share.
14-6 The total sales-mix variance arises from differences in the budgeted contribution
margin of the actual and budgeted sales mix. The composite unit concept enables the effect of
individual product changes to be summarized in a single intuitive number by using weights based
on the mix of individual units in the actual and budgeted mix of products sold.
14-7 A favorable sales-quantity variance arises because the actual units of all products sold
exceed the budgeted units of all products sold.
14-8 The sales-quantity variance can be decomposed into (a) a market-size variance (because
the actual total market size in units is different from the budgeted market size in units), and (b) a
market share variance (because the actual market share of a company is different from the
budgeted market share of a company). Both variances use the budgeted average contribution
margin per unit.

14-1
14-9 Some companies who believe that reliable information on total market size is not
available, choose not to compute market-size and market-share variances.

14-10 Customer profitability analysis highlights to managers how individual customers

differentially contribute to total profitability. It helps managers to see whether customers who
contribute sizably to total profitability are receiving a comparable level of attention from the
organization.

14-11 Companies that separately record (a) the list price and (b) the discount have sufficient
information to subsequently examine the level of discounting by each individual customer and
by each individual salesperson.

14-12 No. A customer-profitability profile highlights differences in current period's

profitability across customers. Dropping customers should be the last resort. An unprofitable
customer in one period may be highly profitable in subsequent future periods. Moreover, costs
assigned to individual customers need not be purely variable with respect to short-run
elimination of sales to those customers. Thus, when customers are dropped, costs assigned to
those customers may not disappear in the short run.

14-13 Five categories in a customer cost hierarchy are identified in the chapter. The examples
given relate to the Spring Distributor Company used in the chapter:
• Customer output-unit-level costs – costs of activities to sell each unit (case) to a customer. An
example is product-handling costs of each case sold.
• Customer batch-level costs – costs of activities that are related to a group of units (cases) sold
to a customer. Examples are costs incurred to process orders or to make deliveries.
• Customer-sustaining costs – costs of activities to support individual customers, regardless of
the number of units or batches of product delivered to the customer. Examples are costs of
visits to customers or costs of displays at customer sites.
• Distribution-channel costs – costs of activities related to a particular distribution channel
rather than to each unit of product, each batch of product, or specific customers. An example
is the salary of the manager of Spring's retail distribution channel.
• Corporate-sustaining costs – costs of activities that cannot be traced to individual customers
or distribution channels. Examples are top management and general administration costs.

14-14 A process where the inputs are nonsubstitutable leaves workers no discretion as to the
inputs (such as, types of materials or labor) to use. A process where the inputs are substitutable
means there is discretion about the exact number and type of inputs to produce output.

14-15 The direct materials efficiency variance is a Level 3 variance. Further insight into this
variance can be gained by moving to a Level 4 analysis where the effect of mix and yield
changes are quantified. The mix variance captures the effect of a change in the relative
percentage use of each input relative to that budgeted. The yield variance captures the effect of a
change in the total number of inputs required to obtain a given output relative to that budgeted.

14-2
14-16 (15-20 min.) Cost allocation in hospitals, alternative allocation
criteria.
1. Direct costs = $2.40
Indirect costs = $11.52 – $2.40 = $9.12
Overhead rate = = 380%
2. The answers here are less than clear-cut in some cases.
Overhead Cost Item Allocation Criteria
Processing of paperwork for purchase Cause and effect

Supplies room management fee Benefits received

Operating-room and patient-room handling Cause and effect

costs

Administrative hospital costs Benefits received

University teaching-related costs Ability to bear

Malpractice insurance costs Ability to bear or benefits received

Cost of treating uninsured patients Ability to bear

Profit component None. This is not a cost.

3. Assuming that Meltzer's insurance company is responsible for paying the $4,800 bill,
Meltzer probably can only express outrage at the amount of the bill. The point of this question is
to note that even if Meltzer objects strongly to one or more overhead items, it is his insurance
company that likely has the greater incentive to challenge the bill. Individual patients have very
little power in the medical arena. In contrast, insurance companies have considerable power and
may decide that certain costs are not reimbursable––for example, the costs of treating uninsured
patients.

14-17 (15 min.) Cost allocation and motivation.

Because corporate policy encourages line managers to seek legal counsel on pertinent issues
from the Legal Department, any step in the direction of reducing costs of legal department
services would be consistent with the corporate policy.
Currently a user department is charged a standard fee of $400 per hour based on actual
usage. It is possible that some managers may not be motivated to seek the legal counsel they
need due to the high-allocated cost of the service. It is also possible that those managers whose
departments are currently experiencing budgetary cost overruns may be disinclined to make use
of the service; it would save them from the Legal Department’s cost allocation. However, it
could potentially result in much costlier penalties for Environ later if the corporation
inadvertently engaged in some activities that violated one or more laws.

14-3
14-17 (Cont’d.)

It is quite likely that the line managers would seek legal counsel, whenever there were
any pertinent legal issues, if the service were free. Making the service of the Legal Department
free, however, might induce some managers to make excessive use of the service. To avoid any
potential abuse, Environ may want to adjust the rate downward considerably, perhaps at a level
lower than what it would cost if outside legal services were sought, but not eliminate it
altogether. As long as the managers know that their respective departments would be charged for
using the service, they would be disinclined to make use of it unnecessarily. However, they
would be motivated to use it when necessary because it would be considered a “good value” if
the standard hourly rate was low enough.

14-18 (30 min.) Cost allocation to divisions.

1.
Hotel Restaurant Casino Rembrandt
Revenue $16,425,000 $5,256,000 $12,340,000 $34,021,000
Direct costs 9,819,260 3,749,172 4,248,768 17,817,200
Segment margin $ 6,605,740 $1,506,828 $ 8,091,232 16,203,800
Indirect costs 14,550,000
Income before taxes $ 1,653,800
Segment margin % 40.22% 28.67% 65.57%

2.
Hotel Restaurant Casino Rembrandt
Direct costs $9819260 $3749172 $4248768 $17817200
Direct cost % 55.11% 21.04% 23.85% 100.00%
Square footage 80,000 16,000 64,000 160,000
Square footage % 50.00% 10.00% 40.00% 100.00%
# of Employees 200 50 250 500
# of Employees % 40.00% 10.00% 50.00% 100.00%

A: Cost allocation based on direct costs:

Hotel Restaurant Casino Rembrandt

Revenue $16,425,000 $ 5,256,000 $12,340,000 $34,021,000
Direct costs 9,819,260 3,749,172 4,248,768 17,817,200
Segment margin 6,605,740 1,506,828 8,091,232 16,203,800
Allocated indirect costs 8,018,505 3,061,320 3,470,175 14,550,000
Segment pre-tax income $( 1,412,765) $ (1,554,492) $ 4,621,057 $ 1,653,800

Segment pre-tax income % -8.60% -29.58% 37.45%

14-4
14-18 (Cont’d.)

B: Cost allocation based on floor space:

Hotel Restaurant Casino Rembrandt

Allocated indirect costs $7,275,000 $1,455,000 $5,820,000 $14,550,000
Segment pre-tax income $ (669,260) $ 51,828 $2,271,232 $ 1,653,800
Segment pre-tax income % -4.07% 0.99% 18.41%

C: Cost allocation based on # of employees

Hotel Restaurant Casino Rembrandt

Allocated indirect costs $5,820,000 $1,455,000 $7,275,000 $14,550,000
Segment pre-tax income $ 785,740 $ 51,828 $ 816,232 $ 1,653,800
Segment pre-tax income % 4.78% 0.99% 6.61%

3. The segment pre-tax income percentages show the dramatic effect of choice of the cost
allocation base on reported numbers:

Denominator Hotel Restaurant Casino

Direct costs -8.60% -29.58% 37.45%
Floor space -4.07 0.99 18.41
# of employees 4.78 0.99 6.61

The decision context should guide a. whether costs should be allocated, and b. the preferred
cost allocation base. Decisions about, say, performance measurement may be made on a
combination of financial and nonfinancial measures. It may well be that Rembrandt may prefer
to exclude allocated costs from the financial measures to reduce areas of dispute.

Where cost allocation is required, the cause-and-effect and benefits-received criteria are
recommended in Chapter 14. The $14,550,000 is a fixed overhead cost. This means that on a
short-run basis, the cause-and-effect criterion is not appropriate but Rembrandt could attempt to
identify the cost drivers for these costs in the long run when these costs are likely to be more
variable. Rembrandt should look at how the $14,550,000 cost benefits the three divisions. This
will help guide the choice of an allocation base in the short run.

4. The analysis in requirement 2 should not guide the decision on whether to shut down any of
the divisions. The overhead costs are fixed costs in the short run. It is not clear how these costs
would be affected in the long run if Rembrandt shut down one of the divisions. Also, each
division is not independent of the other two. A decision to shut down, say, the restaurant likely
would negatively affect the attendance at the casino and possibly the hotel. Rembrandt should
examine the future revenue and future cost implications of different resource investments in the
three divisions. This is a future-oriented exercise, whereas the analysis in requirement 2 is an
analysis of past costs.

14-5
14-19 (25 min.) Cost allocation to divisions.

1. Pulp Paper Fibers

Segment margin $3,200,000 $7,100,000 $9,700,000

Percentages 16.0% 35.5% 48.5%
Allocation: ($9,000,000 ×
16.0%, 35.5%, 48.5%) $1,440,000 $3,195,000 $4,365,000

2. Percentages for new bases of allocation

Pulp Paper Fibers

Number of employees 300 250 450

Percentages 30% 25% 45%
Floor space (square feet) 30,000 24,000 66,000
Percentages 25% 20% 55%
Divisional administrative $1,200,000 $1,800,000 $3,000,000
Percentages 20% 30%
50%

Allocation of indirect costs

Pulp Paper Fibers
Human resource management
($1,800,000 × 30%, 25%, 45%) $ 540,000 $ 450,000 $ 810,000
Facility
($2,700,000 × 25%, 20%, 55%) 675,000 540,000 1,485,000
Corporate administration
($4,500,000 × 20%, 30%, 50%) 900,000 1,350,000 2,250,000
Total $2,115,000 $2,340,000 $4,545,000

3. The new approach is preferable because it is based on cause-and-effect relationships

between costs and their respective cost drivers in the long run.
Human resource management costs are allocated using the number of employees in each
division because the costs for recruitment, training, etc., are mostly related to the number of
employees in each division. Facility costs are mostly incurred on the basis of space occupied by
each division. Corporate administration costs are allocated on the basis of divisional
administrative costs because these costs are incurred to provide support to divisional
administrations.

14-6
14-20 (2030 min.) Customer profitability, service company.
1. (in thousands)

Customer
Customer Customer Operating
Revenues Costs Income
Avery Group $ 260 $182 $ 78
Duran Systems 180 184 (4)
Retail Systems 163 178 (15)
Wizard Partners 322 225 97
Santa Clara College 235 308 (73)
Grainger Services 80 74 6
Software Partners 174 100 74
Problem Solvers 76 108 (32)
Business Systems 137 110 27
Okie Enterprises 373 231 142
Solution Exhibits 14-20A and 14-20B present the summary results. The two most profitable
customers provide 80% of total operating income.
2. The options Instant Service should consider include:
a. Increase the attention paid to Okie Enterprises and Wizard Partners. These are "key
customers," and every effort has to be made to ensure they retain IS. IS may well want to
suggest a minor price reduction to signal how important it is in their view to provide a
cost-effective service to these customers.
b. Seek ways of reducing the costs or increasing the revenues of the problem accounts––
Santa Clara College and Problem Solvers. For example, are the copying machines at
Santa Clara outdated and in need of repair? If yes, an increased charge may be
appropriate. Can IS provide better on-site guidelines to users about ways to reduce
breakdowns?
c. As a last resort, IS may want to consider dropping particular accounts. For example, if
Santa Clara College will not agree to a fee increase but has machines continually
breaking down, IS may well decide that it is time not to bid on any more work for this
customer.
3. Major problems in accurately estimating the operating costs of each customer are:
a. Basic underlying records may not be accurate. For example, some technicians include
travel time, break time, etc., in their time records to create an appearance of high work
effort.
b. Not all costs for individual repair people are easily assignable to individual customers.
For example, how is the cost of a trip to pick up parts for three customers assigned among
individual customers?
c. Many costs of IS are not related to specific customers. For example, advertising by IS is
aimed at a general market rather than being targeted to a specific potential customer.

14-7
14-20 (Cont’d.)

SOLUTION EXHIBIT 14-20A

Panel A: Customers Ranked on Customer-Level Operating Income

Customer Operating
Operating Cumulative Income as
Customer Income Customer a % of Total
Operating Customer Divided Operating Operating
Income Revenue By Revenue Income Income
(1) (2) (3) = (1) ÷ (2) (4) (5) = (4)  $300
Okie Ent. $142 $ 373 38% $142 47%
Wizard P. 97 322 30 239 80
Avery Group 78 260 30 317 106
Software P. 74 174 43 391 130
Business S. 27 137 20 418 139
Grainger S. 6 80 8 424 141
Duran S. (4) 180 (2) 420 140
Retail S. (15) 163 (9) 405 135
Problem S. (32) 76 (42) 373 124
Santa Clara (73) 235 (31) 300 100
$300 $2,000

14-8
14-20 (Cont’d.)

SOLUTION EXHIBIT 14-20B

Bar Chart of Customer Operating Income

Operating
Income
OKIE, $142

$150

WIZARD, $97

AVERY, $78

$100 SOFTWARE, $74

BUSINESS, $27
$50

GRAINGER, $6

$0
DURAN ($4)

RETAIL ($15)

PROBLEM ($32)
-$50
SANTA ($73)

-$100

14-9
14-21 (2025 min.) Customer profitability, distribution.
1. The activity-based costing for each customer is:
Charleston Chapel Hill
Pharmacy Pharmacy

1. Order processing,
$40 × 12; $40 × 10 $ 480 $ 400
2. Line-item ordering,
$3 × (12 × 10;10 × 18) 360 540
3. Store deliveries,
$50 × 6; $50 ×10 300 500
4. Carton deliveries,
$1 × (6 × 24; 10 × 20) 144 200
5. Shelf-stocking,
$16 × (6 × 0; 10 × 0.5) 0 80
Operating costs $1,284 $1,720
The operating income of each customer is:
Charleston Chapel Hill
Pharmacy Pharmacy
Revenues,
$2,400 × 6; $1,800 × 10 $14,400 $18,000
Cost of goods sold,
$2,100 × 6; $1,650 × 10 12,600 16,500
Gross margin 1,800 1,500
Operating costs 1,284 1,720
Operating income $ 516 $ (220)
Chapel Hill Pharmacy has a lower gross margin percentage than Charleston (8.33% vs. 12.50%)
and consumes more resources to obtain this lower margin.
2. Ways Figure Four could use this information include:
a. Pay increased attention to the top 20% of the customers. This could entail asking them for
ways to improve service. Alternatively, you may want to highlight to your own personnel
the importance of these customers; e.g., it could entail stressing to delivery people the
importance of never missing delivery dates for these customers.
b. Work out ways internally at Figure Four to reduce the rate per cost driver; e.g., reduce the
cost per order by having better order placement linkages with customers. This cost
reduction by Figure Four will improve the profitability of all customers.
c. Work with customers so that their behavior reduces the total "system-wide" costs. At a
minimum, this approach could entail having customers make fewer orders and fewer line
items. This latter point is controversial with students; the rationale is that a reduction in the
number of line items (diversity of products) carried by Ma and Pa stores may reduce the
diversity of products Figure Four carries.

14-10
14-21 (Cont'd.)

There are several options here:

• Simple verbal persuasion by showing customers cost drivers at Figure Four.
• Explicitly pricing out activities like cartons delivered and shelf-stocking so that customers
pay for the costs they cause.
• Restricting options available to certain customers, e.g., customers with low revenues could be
restricted to one free delivery per week.

An even more extreme example is working with customers so that deliveries are easier to make
and shelf-stocking can be done faster.

d. Offer salespeople bonuses based on the operating income of each customer rather than
the gross margin of each customer.

Some students will argue that the bottom 40% of the customers should be dropped. This
action should be only a last resort after all other avenues have been explored. Moreover, an
unprofitable customer today may well be a profitable customer tomorrow, and it is myopic to
focus on only a 1-month customer-profitability analysis to classify a customer as unprofitable.

14-22 (30–40 min.) Variance analysis, multiple products.

1.

=  

Lower-tier tickets = (3,300 – 4,000)  $20 = $14,000 U

Upper-tier tickets = (7,700 – 6,000)  $ 5 = 8,500 F
All tickets $ 5,500 U

2.
=

= =

= $11 per unit (seat sold)

14-11
14-22 (Cont'd.)

Sales-mix percentages:
Budgeted Actual

Lower-tier
= 0.40 = 0.30

Upper-tier
= 0.60 = 0.70

Solution Exhibit 14-22 presents the sales-volume, sales-quantity, and sales-mix variances for
lower-tier tickets, upper-tier tickets, and in total for Detroit Penguins in 2004.

The sales-quantity variances can also be computed as:

=  

The sales-quantity variances are:

Lower-tier tickets = (11,000 – 10,000) × 0.40 × $20 = $8,000 F
Upper-tier tickets = (11,000 – 10,000) × 0.60 × $ 5 = 3,000 F
All tickets $11,000 F

The sales-mix variance can also be computed as:

= ×

The sales-mix variances are:

Lower-tier tickets = 11,000 × (0.30 – 0.40) × $20 = $22,000 U
Upper-tier tickets = 11,000 × (0.70 – 0.60) × $ 5 = 5,500 F
All tickets $16,500 U

3. The Detroit Penguins increased average attendance by 10% per game. However, there
was a sizable shift from lower-tier seats (budgeted contribution margin of $20 per seat) to the
upper-tier seats (budgeted contribution margin of $5 per seat). The net result: the actual
contribution margin was $5,500 below the budgeted contribution margin.

14-12
14-22 (Cont'd.)

SOLUTION EXHIBIT 14-22

Columnar Presentation of Sales-Volume, Sales-Quantity and Sales-Mix Variances for Detroit Penguins

Flexible Budget: Static Budget:

Actual Units of Actual Units of Budgeted Units of
All Products Sold All Products Sold All Products Sold
× Actual Sales Mix × Budgeted Sales Mix × Budgeted Sales Mix
× Budgeted × Budgeted × Budgeted
Contribution Contribution Margin Contribution
Margin per Unit per Unit Margin per Unit
(1) (2) (3)
Panel A:
Lower-tier (11,000 × 0.30a) × $20 (11,000 × 0.40b) × $20 (10,000 × 0.40b) × $20
3,300 × $20 4,400 × $20 4,000 × $20
$66,000 $88,000 $80,000
$22,000U $8,000 F
Sales-mix variance Sales-quantity variance
$14,000 U
Sales-volume variance
Panel B:
Upper-tier (11,000 × 0.70c) × $5 (11,000 × 0.60d) × $5 (10,000 × 0.60d) × $5
7,700 × $5 6,600 × $5 6,000 × $5
$38,500 $33,000 $30,000
$5,500 F $3,000 F
Sales-mix variance Sales-quantity variance
$8,500 F
Sales-volume variance
Panel C: $104,500e $121,000f $110,000g
All Tickets $16,500 U $11,000 F
(Sum of Lower- Total sales-mix variance Total sales-quantity variance
tier and Upper- $5,500 U
Total sales-volume variance
tier tickets)

F = favorable effect on operating income; U = unfavorable effect on operating income.

Actual Sales Mix: Budgeted Sales Mix:

aLower-tier = 3,300 ÷ 11,000 = 30% bLower-tier = 4,000 ÷ 10,000 = 40%
cUpper-tier = 7,700 ÷ 11,000 = 70% dUpper-tier = 6,000 ÷ 10,000 = 60%
e$66,000 + 38,500 = $104,500 f $88,000 + $33,000 = $121,000
g $80,000 + $30,000 = $110,000

14-13
14-22 (Cont'd.)

14-22 Excel Application

Revenues, Sales Variances, and
Customer Profitability Analysis
Detroit Penguins

Original Data
Lower-Tier Upper-Tier
Tickets Tickets
Selling price $35 $14
Downtown arena fee 10 6
Reservation network fee 5 3
Contribution margin per ticket $20 $ 5

Budgeted Actual
Seats Sold Seats Sold
Lower-Tier 4,000 3,300
Upper-Tier 6,000 7,700
Total 10,000 11,000

Problem 1
Sales Volume Variance calculations
Lower-tier tickets $(14,000) U
Upper-tier tickets $ 8,500 F
All tickets $ (5,500) U

Problem 2

Sales - mix percentages

Budgeted Actual
Lower-tier 0.4 0.3
Upper-tier 0.6 0.7

Sales-quantity variance calculations

Lower-tier tickets $ 8,000 F
Upper-tier tickets $ 3,000 F
All tickets $11,000 F

Sales-mix variance calculations

Lower-tier tickets $(22,000) U
Upper-tier tickets $ 5,500 F
All tickets $(16,500) U

14-14
14-23 (30 min.) Variance analysis, working backward.
1, and 2. Solution Exhibit 14-23 presents the sales-volume, sales-quantity, and sales-mix
variances for the Plain and Chic wine glasses and in total for Jinwa Corporation in June 2003.
The steps to fill in the numbers in Solution Exhibit 14-23 follow:
Step 1:
Consider the static budget column (Column 3):
Static budget total contribution margin $5,600
Budgeted units of all glasses to be sold 2,000
Budgeted contribution margin per unit of Plain $2
Budgeted contribution margin per unit of Chic $6
Suppose that the budgeted sales-mix percentage of Plain is y. Then the budgeted sales-mix
percentage of Chic is (1 – y). Hence,

(2,000y  $2) + (2,000  (1 – y)  $6) = $5,600

4000y + 12,000 – 12,000y = 5,600
8,000y = 6,400
y = 0.8 or 80%

1 – y = 1 – 0.8 = 0.2 or 20%

Jinwa's budgeted sales mix is 80% of Plain and 20% of Chic. We can then fill in all the numbers
in Column 3.

Step 2:

Next, consider Column 2 of Solution Exhibit 14-23.

The total of Column 2 in Panel C is $4,200 (the static budget total contribution margin of
$5,600––the total sales-quantity variance of $1,400 U which was given in the problem).

We need to find the actual units sold of all glasses, which we denote by q. From Column 2, we
know that

(q  0.8  $2) + (q  0.2  $6) = $4,200

$1.6q + $1.2q = $4,200
$2.8q = $4,200
q = 1,500 units

Hence, the total quantity of all glasses sold is 1,500 units. This computation allows us to fill in
all the numbers in Column 2.

Step 3:
Next, consider Column 1 of Solution Exhibit 14-23. We know actual units sold of all
glasses (1,500 units), the actual sales-mix percentage (given in the problem information as Plain,
60%; Chic, 40%), and the budgeted unit contribution margin of each product (Plain, $2; Chic,
$6). We can therefore determine all the numbers in Column 1.

14-15
14-23 (Cont’d.)

Solution Exhibit 14-23 displays the following sales-quantity, sales-mix, and sales-volume
variances:

Sales-Volume Variance
Plain $1,400 U
Chic 1,200 F
All Glasses $ 200 U

Sales-Mix Variances Sales-Quantity Variances

Plain $ 600 U Plain $ 800 U
Chic 1,800 F Chic 600 U
All Glasses $1,200 F All Glasses $1,400 U

3. Jinwa Corporation shows an unfavorable sales-quantity variance because it sold fewer wine
glasses in total than was budgeted. This unfavorable sales-quantity variance is partially offset by
a favorable sales-mix variance because the actual mix of wine glasses sold has shifted in favor of
the higher contribution margin Chic wine glasses. The problem illustrates how failure to achieve
the budgeted market penetration can have negative effects on operating income.

14-16
14-23 (Cont’d.)

SOLUTION EXHIBIT 14-23

Columnar Presentation of Sales-Volume, Sales-Quantity and Sales-Mix Variances
for Jinwa Corporation

Flexible Budget: Static Budget:

Actual Units Sold Actual Units Sold Budgeted Units Sold
of All Glasses of All Glasses of All Glasses
 Actual Sales Mix  Budgeted Sales Mix  Budgeted Sales Mix
 Budgeted  Budgeted  Budgeted
Contribution Contribution Contribution
Margin per Unit Margin per Unit Margin per Unit
Panel A: (1,500  0.6)  $2 (1,500  0.8)  $2 (2,000  0.8)  $2
Plain 900  $2 1,200  $2 1,600  $2
$1,800 $2,400 $3,200
$600 U $800 U
Sales-mix variance Sales-quantity variance
$1,400 U
Sales-volume variance

Panel B: (1,500  0.4)  $6 (1,500  0.2)  $6 (2,000  0.2)  $6

Chic 600  $6 300  $6 400  $6
$3,600 $1,800$2,400
$1,800 F $600 U
Sales-mix variance Sales-quantity variance
$1,200 F
Sales-volume variance

Panel C: $5,400 $4,200 $5,600

All Glasses $1,200 F $1,400 U
Total sales-mix variance Total sales-quantity variance
$200 U
Total sales-volume variance

F = favorable effect on operating income; U = unfavorable effect on operating income.

14-17
14-24 (60 min.) Variance analysis, multiple products.
1. Budget for 2003

Variable Contrib.
Selling Cost Margin Units Sales Contribution
Price per Unit per Unit Sold Mix Margin
(1) (2) (3) = (1) – (2) (4) (5) (6) = (3) × (4)
Kola $6.00 $4.00 $2.00 400,000 16% $ 800,000
Limor 4.00 2.80 1.20 600,000 24 720,000
Orlem 7.00 4.50 2.50 1,500,000 60 3,750,000
Total 2,500,000 100% $5,270,000

Actual for 2003

Variable Contrib.
Selling Cost Margin Units Sales Contribution
Price per Unit per Unit Sold Mix Margin
(1) (2) (3) = (1) – (2) (4) (5) (6) = (3) × (4)
Kola $6.20 $4.50 $1.70 480,000 16% $ 816,000
Limor 4.25 2.75 1.50 900,000 30 1,350,000
Orlem 6.80 4.60 2.20 1,620,000 54 3,564,000
Total 3,000,000 100% $5,730,000

Solution Exhibit 14-24 presents the sales-volume, sales-quantity, and sales-mix variances for
each product and in total for 2003.

Sales-volume Actual sales Budgeted sales Budgeted

variance = quantity – quantity × contrib. margin
in units in units per unit

Kola = ( 480,000 – 400,000) × $2.00 = $160,000 F

Limor = ( 900,000 – 600,000) × $1.20 = 360,000 F
Orlem = (1,620,000 – 1,500,000) × $2.50 = 300,000 F
Total $820,000 F

Actual units Budgeted units Budgeted Budgeted

Sales-quantity
= of all products – of all products × sales-mix × contrib. margin
variance
sold sold percentage per unit

Kola = (3,000,000 – 2,500,000) × 0.16 × $2.00 = $ 160,000 F

Limor = (3,000,000 – 2,500,000) × 0.24 × $1.20 = 144,000 F
Orlem = (3,000,000 – 2,500,000) × 0.60 × $2.50 = 750,000 F
Total $1,054,000 F

14-18
14-24 (Cont’d.)

Actual units Actual Budgeted Budgeted

Sales-mix = of all products × sales-mix – sales-mix × contrib. margin
variance sold percentage percentage per unit

Kola = 3,000,000 × (0.16 – 0.16) × $2.00 = $ 0

Limor = 3,000,000 × (0.30– 0.24) × $1.20 = 216,000 F
Orlem = 3,000,000 × (0.54 – 0.60) × $2.50 = 450,000 U
Total $234,000 U

2. The breakdown of the favorable sales-volume variance of $820,000 shows that the biggest
contributor is the 500,000 unit increase in sales resulting in a favorable sales-quantity variance of
$1,054,000. There is a partially offsetting unfavorable sales-mix variance of $234,000 in contribution
margin.

SOLUTION EXHIBIT 14-24

Sales-Mix and Sales-Quantity Variance Analysis of Soda King for 2003

Flexible Budget: Static Budget:

Actual Units of Actual Units of Budgeted Units of
All Products Sold All Products Sold All Products Sold
 Actual Sales Mix  Budgeted Sales Mix  Budgeted Sales Mix
 Budgeted Contribution  Budgeted Contribution  Budgeted Contribution
Margin Per Unit Margin Per Unit Margin Per Unit
Kola 3,000,000  0.16  $2 = $ 960,000 3,000,000  0.16  $2 = $ 960,000 2,500,000  0.16  $2 =$
800,000
Limor 3,000,000  0.30  $1.20 = 1,080,000 3,000,000  0.24  $1.20 = 864,000 2,500,000  0.24  $1.20 =
720,000
Orlem 3,000,000  0.54  $2.50 = 4,050,000 3,000,000  0.60  $2.50 = 4,500,000 2,500,000  0.60  $2.50 =
3,750,000
$6,090,000 $6,324,000 $5,270,000

$234,000 U $1,054,000 F
Sales-mix variance Sales-quantity variance

$820,000 F
Sales-volume variance

F = favorable effect on operating income; U= unfavorable effect on operating income

14-19
14-25 (20 min.) Market-share and market-size variances (continuation of 14-24).

Actual Budgeted
Western region 24 million 25 million
Soda King 3 million 2.5 million
Market share 12.5% 10%

Average budgeted contribution margin per unit = $2.108 ($5,270,000 ÷ 2,500,000)

Solution Exhibit 14-25 presents the sales-quantity variance, market-size variance, and market-
share variance for 2003.

Actual Actual Budgeted Budgeted contribution

Market-share = market size × market – market × margin per composite
variance in units share share unit for budgeted mix

= 24,000,000 × (0.125 – 0.10) × $2.108

= 24,000,000 × .025 × $2.108
= $1,264,800 F

Actual Budgeted Budgeted Budgeted contribution

Market-size = market size – market size × market × margin per composite
variance in units in units share unit for budgeted mix

= (24,000,000 – 25,000,000) × 0.10 × $2.108

= – 1,000,000 × 0.10 × $2.108
= 210,800 U

The market share variance is favorable because the actual 12.5% market share was higher than
the budgeted 10% market share. The market size variance is unfavorable because the market size
decreased 4% [(25,000,000 – 24,000,000) ÷ 25,000,000].

While the overall total market size declined (from 25 million to 24 million), the increase in
market share meant a favorable sales-quantity variance.

Sales-Quantity Variance
$1,054,000 F

Market-share variance Market-size variance

$1,264,800 F $210,800 U

14-20
14-25 (Cont’d.)
SOLUTION EXHIBIT 14-25
Market-Share and Market-Size Variance Analysis of Soda King for 2003
Static Budget:
Actual Market Size Actual Market Size Budgeted Market Size
 Actual Market Share  Budgeted Market Share  Budgeted Market Share
 Budgeted Average  Budgeted Average  Budgeted Average
Contribution Margin Contribution Margin Contribution Margin
Per Unit Per Unit Per Unit
24,000,000  0.125a  $2.108b 24,000,000  0.10c  $2.108 b 25,000,000  0.10c  $2.108b
$6,324,000 $5,059,200 $5,270,000
$1,264,800 F $210,800 U
Market-share variance Market-size variance
$1,054,000 F
Sales-quantity variance
F = favorable effect on operating income; U = unfavorable effect on operating income
a
Actual market share: 3,000,000 units ÷ 24,000,000 units = 0.125, or 12.5%
b
Budgeted average contribution margin per unit $5,270,000 ÷ 2,500,000 units = $2.108 per unit
c
Budgeted market share: 2,500,000 units ÷ 25,000,000 units = 0.10, or 10%
14-26 (40 min.) Allocation of central corporate costs to divisions.
1. The purposes for allocating central corporate costs to each division include:
a. To provide information for economic decisions. Allocations can signal to division
managers that decisions to expand (contract) activities will likely require increases
(decreases) in corporate costs that should be considered in the initial decision about
expansion (contraction). When top management is allocating resources to divisions,
analysis of relative division profitability should consider differential use of corporate
services by divisions. Some allocation schemes can encourage the use of central services
that would otherwise be underutilized. A common rationale related to this purpose is "to
remind profit center managers that central corporate costs exist and that division earnings
must be adequate to cover some share of those costs."
b. Motivation. Creates an incentive for division managers to control costs; for example, by
reducing the number of employees at a division, a manager will save direct labor costs as
well as central personnel and payroll costs allocated on the basis of number of
employees. Allocation also creates incentives for division managers to monitor the
effectiveness and efficiency with which central corporate costs are spent.
c. Cost justification or reimbursement. Some lines of business of Richfield Oil may be
regulated with cost data used in determining "fair prices"; allocations of central corporate
costs will result in higher prices being set by a regulator.
d. Income measurement for external parties. Richfield Oil may include allocations of
central corporate costs in its external line-of-business reporting.
Instructors may wish to discuss the "Surveys of Company Practice" evidence from the
United States, Canada, Australia, and the United Kingdom in Chapter 14 (p. 488).
2. Total costs in single pool = $3,000
Allocation base = $30,000 revenue
Allocation rate = $3,000 ÷ $30,000 = $0.10 per $1 of revenue
See Solution Exhibit 14-26 for additional answers.

14-21
14-26 (Cont’d.)

3. See Solution Exhibit 14-26 for answer.

SOLUTION EXHIBIT 14-26

(in millions)
Oil & Gas Oil & Gas Chemical Copper
Upstream Downstream Products Mining Total
Revenues $7,000 $16,000 $4,000 $3,000 $30,000
Operating costs 3,000 15,000 3,800 3,200 25,000
Allocated costs,
$0.10 per $1 revenue 700 1,600 400 300 3,000
Division income $3,300 $ (600) $ (200) $ (500) $ 2,000

Oil & Gas Oil & Gas Chemical Copper

Allocation Base Upstream Downstream Products Mining
1. Allocated on basis of
identifiable assets 14/25 6/25 3/25 2/25
Total costs = $2,000 $1,120 $480 $240 $160

2. Allocated on basis of
revenues 7/30 16/30 4/30 3/30
Total costs = $600 $140 $320 $ 80 $ 60

3. Allocated on basis of
operating income (if
positive) 40/52 10/52 2/52 --
Total costs = $208 $160 $ 40 $ 8 $ 0

4. Allocated on basis of
number of employees 9/30 12/30 6/30 3/30
Total costs = $192 $ 57.6 $ 76.8 $ 38.4 $ 19.2

Oil & Gas Oil & Gas Chemical Copper

Upstream Downstream Products Mining Total
Revenues $7,000 $16,000 $4,000 $3,000 $30,000
Operating costs 3,000 15,000 3,800 3,200 25,000
Cost Pool 1 Allocation 1,120 480 240 160 2,000
Cost Pool 2 Allocation 140 320 80 60 600
Cost Pool 3 Allocation 160 40 8 0 208
Cost Pool 4 Allocation 57.6 76.8 38.4 19.2 192
Division income $2,522.4 $ 83.2 $ (166.4) $ (439.2) $ 2,000

14-22
14-26 (Cont’d)

4. Strengths of Rhodes' proposal relative to existing single-cost pool method:

a. Better able to capture cause-and-effect relationships. Interest on debt is more likely caused
by the financing of assets than by revenues. Personnel and payroll costs are more likely caused
by the number of employees than by revenues.

b. Relatively simple. No extra information need be collected beyond that already available.
(Some students will list the extra costs of Rhodes' proposal as a weakness. However, for a
company with $30 billion in revenues, those extra costs are minimal.)

Weaknesses of Rhodes' proposal relative to existing single-cost pool method:

a. May promote dysfunctional decision making. May encourage division managers to lease
or rent assets rather than to purchase assets, even where it is economical for Richfield Oil to
purchase them. This off-balance sheet financing will reduce the "identifiable assets" of the
division and thus will reduce the interest on debt costs allocated to the division. (Richfield Oil
could counteract this problem by incorporating leased and rented assets in the "identifiable
assets" base.)

Note: Some students criticized Rhodes' proposal, even though agreeing that it is preferable to the
existing single-cost pool method. These criticisms include:

a. Proposal does not adequately capture cause-and-effect relationships for the legal and
research and development cost pools. For these cost pools, specific identification of individual
projects with an individual division can better capture cause-and-effect relationships.

b. Proposal may give rise to disputes over the definition and valuation of "identifiable assets."

c. Use of actual rather than budgeted amounts in the allocation bases creates
interdependencies between divisions. Moreover, use of actual amounts means that division
managers do not know cost allocation consequences of their decisions until the end of each
reporting period.

d. Separate allocation of fixed and variable costs would result in more refined cost
allocations.

e. Questionable that 100% of central corporate costs should be allocated. Many students
argue that public affairs should not be allocated to any division, based on the notion that division
managers may not control many of the individual expenditures in this cost pool.

14-23
14-27 (25-30 min.) Allocation of central corporate costs to divisions.

Print Book
Total Multimedia Broadcasting Media Publishing

Interest on debt $ 10,000,000 $ 3,500,000 $ 6,500,000 $ -0- $ -0-

Research and
development
(40%, 30%, 0%,
30%) 100,000,000 40,000,000 30,000,000 -0- 30,000,000

Advertising (1,400:
4,500: 2,500:
1,600) 200,000,000 28,000,000 90,000,000 50,000,000 32,000,000

Human resource
management
(1,000: 3,000:
2,500: 1,500) 150,000,000 18,750,000 56,250,000 46,875,000 28,125,000

Corporate adminis-
tration (150: 400:
250: 200) 50,000,000 7,500,000 20,000,000 12,500,000 10,000,000

Total $510,000,000 $ 97,750,000 $202,750,000 $109,375,000 $100,125,000

14-24
14-28 (60 min.) Customer-profitability analysis, customer cost hierarchy.
1.

Item April Madison Suitors Design

Revenues at list prices
17,600a × $200; 12,400b × $200;
6,360c × $200; 6,250d × $200 $3,520,000 $2,480,000 $1,272,000 $1,250,000
Discount
17,600 × $60e; 12,400 × $40f;
6,360 × $30g; 6,250 × $20h 1,056,000 496,000 190,800 125,000
Revenues (at actual prices) 2,464,000 1,984,000 1,081,200 1,125,000
Cost of goods sold
17,600 × $110; 12,400 × $110;
6,360 × $110; 6,250 × $110 1,936,000 1,364,000 699,600 687,500
Gross Margin 528,000 620,000 381,600 437,500
Customer-level operating costs
Order processing
44, 62, 212, 250 × $245 10,780 15,190 51,940 61,250
Sales visits
8, 12, 22, 20 × $1,430 11,440 17,160 31,460 28,600
Delivery – regular
41, 48, 166, 190 × $300 12,300 14,400 49,800 57,000
Delivery – rushed
3, 14, 46, 60 × $850 2,550 11,900 39,100 51,000
Total customer-level operating
costs 37,070 58,650 172,300 197,850
Customer-level operating income $ 490,930 $ 561,350 $ 209,300 $ 239,650
a
44 × 400 = 17,600
b
62 × 200 = 12,400
c
212 × 30 = 6,360
d
250 × 25 = 6,250
e
$200 – $140 = $60
f
$200 – $160 = $40
g
$200 – $170 = $30
h
$200 – $180 = $20

2. Key challenges facing Sims are:

a. Reduce level of price discounting, especially by April
b. Reduce level of customer-level costs, especially by Suitors and Design
The ABC cost system highlights areas where the Suitors and Design accounts are troublesome.
They have:
 A high number of orders,
 A high number of customer visits, and
 A high number of rushed deliveries.
Sims needs to consider whether this high level of activity can be reduced without reducing
customer revenues.

14-25
3. Solution Exhibit 14-28 presents a customer cost hierarchy report for Zoot’s Suits,

14-26
14-27
 14-29 (40 min.) Customer profitability, distribution.
1. Customer
P Q R S T
Revenues at list pricesa $29,952 $126,000 $875,520 $457,920 $56,160
Discountb 0 2,100 72,960 15,264 5,616
Revenues (at actual prices) 29,952 123,900 802,560 442,656 50,544
Cost of goods soldc 24,960 105,000 729,600 381,600 46,800
Gross margin 4,992 18,900 72,960 61,056 3,744
Customer-level operating costs
Order takingd 1,500 2,500 3,000 2,500 3,000
Customer visitse 160 240 480 160 240
Delivery vehiclesf 280 240 360 640 1,600
Product handlingg 1,040 4,375 30,400 15,900 1,950
Expedited runsh 0 0 0 0 300
Total 2,980 7,355 34,240 19,200 7,090
Customer-level operating income $ 2,012 $ 11,545 $ 38,720 $ 41,856 $ (3,346)
a $14.40  2,080; 8,750; 60,800; 31,800; 3,900
b ($0.00  50,000); ($0.24  8,750); ($1.20  60,800);
($0.48  31,800; $1.44  3,900)
c $12  2,080; 8,750; 60,800, 31,800; 3,900
d $100  15; 25; 30; 25; 30
e $80  2; 3; 6; 2; 3
f $2  (10  14); (30  4); (60  3); (40  8); (20  40)
g $0.50  2,080; 8,750; 60,800; 31,800; 3,900
h $300  0; 0; 0; 0; 1

Customer S is the most profitable customer, despite having only 52% of the unit volume of
Customer R. A major explanation is that Customer R receives a $1.20 discount per case while
Customer S receives only a $0.48 discount per case.

Customer T is unprofitable, despite the smaller customer P being profitable. Customer T

receives a $1.44 discount per case, makes more frequent orders, requires more customer visits,
and requires more delivery miles than Customer P.

2. Separate reporting of both the list selling price and the actual selling price enables Spring
Distribution to examine which customers receive different discounts and how salespeople may
differ in the discounts they grant. There is a size pattern in the discounts across the 5 customers,
except for Customer T:

Sales Volume Discount per case

R (60,800 cases) $1.20
S (31,800 cases) $0.48
Q (8,750 cases) $0.24
T (3,900 cases) $1.44
P (2,080 cases) $0.00

14-28
14-29 (Cont'd.)

The reasons for the $1.44 discount for T should be explored.

3. Dropping customers should be the last resort taken by Spring Distribution. Factors to
consider include:

a. What is the expected future profitability of each customer? Are the currently
unprofitable (T) or low-profit (P) customers likely to be highly profitable in the future?

b. Are there externalities from having some customers, even if they are unprofitable in the
short run? For example, some customers have a marque-value that is "in effect" advertising that
benefits the business.

c. What costs are avoidable if one or more customers are dropped?

d. Can the relationship with the "problem" customers be restructured so that there is a "win-
win" situation? For example, could Customer T get by with fewer deliveries per month?

14-30 (40 min.) Customer loyalty clubs and profitability analysis.

1.
Gold Program
Revenues
2,430 × 20 × ($200  0.90) $ 8,748,000
2,430 × 30 × ($200  0.80) 11,664,000
2,430 × 10 × ($200  0.70) 3,402,000
Total revenues 23,814,000
Variable Costs
Hotel variable costs, 2,430  60  $65 9,477,000
Wine Costs
2,430  50  $5 607,500
2,430  10  $20 486,000
Restaurant costs
2,430  20  $10 486,000
2,430  30  $15 1,093,500
2,430  10  $20 486,000
Total variable costs 12,636,000
Contribution margin $11,178,000

14-29
14-30 (Cont’d.)

Silver Program
Revenues
8,340  20  ($200  0.90) $30,024,000

8,340  15  ($200  0.80) 20,016,000

Total revenues 50,040,000
Variable Costs
Hotel variable costs, 8,340 × 35 × $65 18,973,500
Wine costs, 8,340 × 35 × $5 1,459,500
Restaurant Costs
8,340  20  $10 1,668,000
8,340  15  $15 1,876,500
Total variable costs 23,977,500
Contribution margin $26,062,500

Bronze Program
Revenues, 80,300  10  ($200  0.90) $144,540,000
Variable costs
Hotel variable costs, 80,300  10  $65 52,195,000
Wine costs 80,300  10  $5 4,015,000
Restaurant costs 80,300  10  $10 8,030,000
Total variable costs 64,240,000
Contribution margin $ 80,300,000

No Program
Revenues, 219,000 × 1 × $200 $43,800,000
Variable costs, 219,000 × 1 × $65 14,235,000
Contribution margin $29,565,000

Loyalty Total Variable Contribution Contrib. Margin

Program Revenues Costs Margin Total Revenues
Gold $ 23,814,000 $ 12,636,000 $ 11,178,000 46.94%
Silver 50,040,000 23,977,500 26,062,500 52.08
Bronze 144,540,000 64,240,000 80,300,000 55.56
No program 43,800,000 14,235,000 29,565,000 67.50
Total $262,194,000 $115,088,500 $147,105,500

The no-program group of customers has the highest contribution margin per revenue dollar.
However, it comprises only 16.71% ($43,800,000  $262,194,000) of total revenues. The gold
program has the lowest contribution margin per revenue dollar. However, it is misleading to
evaluate each program in isolation. A key aim of loyalty programs is to promote a high
frequency of return business. The contribution margin to total revenue ratio of each program in
isolation does not address this issue.

14-30
14-30 (Cont'd.)

2.
Revenues $262,194,000
Variable costs 115,088,500
Contribution margin 147,105,500
Fixed costs 140,580,000
Operating income $ 6,525,500

3. Number of room nights

Gold, 2,430 × 60 145,800
Silver, 8,340 × 35 291,900
Bronze, 80,300 × 10 803,000
No program, 219,000 × 1 219,000
1,459,700

Average room rate per night:

Average variable cost per night:

4. Sherriton Hotels has fixed costs of $140,580,000. A key challenge is to attract a high
number of repeat business customers. Loyalty programs aim to have customers return to
Sherriton multiple times. Their aim is increasing the revenues beyond what they would be
without the program. It is to be expected that the higher the level of nights stayed, the greater the
inducements necessary to keep attracting the customer to return. However, given the low level
of variable costs to room rates, there is considerable cushion available for Sherriton to offer high
inducements for frequent stayers.

Sherriton could adopt a net present value analysis of customers who are in the different
loyalty clubs. It would be informative for Sherriton to have information on how much of each
customer’s total lodging industry expenditures it captures. It may well want to give higher levels
of inducements to frequent stayers if the current program attracts only, say, 30% of each of its
frequent customer’s total business in cities where it has lodging properties available.

14-31
14-31 (30 min.) Customer profitability, customer cost hierarchy.

1. (All amounts in thousands of U.S. dollars)

Wholesale Retail
North America South America Big Sam World
Wholesaler Wholesaler Stereo Market

Revenues at list prices $400,000 $600,000 $130,000 $100,000

Discount 30,000 50,000 7,000 0
Revenues (at actual prices) 370,000 550,000 123,000 100,000
Cost of goods sold 325,000 490,000 112,000 92,000
Gross margin 45,000 60,000 11,000 8,000
Customer-level operating costs
Product handling 5,000 6,000 800 900
Order processing 800 1,000 200 130
Delivery:
Regular 300 450 150 80
Expedited 120 200 10 5
Sales visit 480 550 240 165
Total cust.-level optg.costs 6,700 8,200 1,400 1,280
Customer-level operating
income $ 38,300 $ 51,800 $ 9,600 $ 6,720

14-32
14-31 (Cont’d.)

2.
Customer Distribution Channels
(All amounts in thousands of U.S. dollars)
Wholesale Customers Retail Customers
North America South America Big Sam World
Total Total Wholesaler Wholesaler Total Stereo Market
Revenues (at
actual prices) $1,143,000 $920,000 $370,000 $550,000 $223,000 $123,000 $100,000
Customer-level
costs 1,036,580 829,900 331,700 498,200 206,680 113,400 93,280
Customer-level
operating income 106,420 90,100 $ 38,300 $ 51,800 16,320 $ 9,600 $ 6,720
Distribution-
channel costs 40,000 30,000 10,000
Distribution-
channel- level
operating income 66,420 $ 60,100 $ 6,320
Corporate-
sustaining costs 60,000
Operating income $ 6,420

14-33
 14-32 (60 min.)Variance analysis, sales-mix, and sales-quantity variances.
1. Actual Contribution Margins
Actual Actual Actual
Actual Variable Contribution Sales Actual Actual
Selling Costs per Margin per Volume in Contribution Contribution
Product Price Unit Unit Units Dollars Percent
Palm Pro $349 $178 $171 11,000 $ 1,881,000 16%
Palm CE 285 92 193 44,000 8,492,000 71%
PalmKid 102 73 29 55,000 1,595,000 13%
110,000 $11,968,000 100%
The actual average contribution margin per unit is $108.80 ($11,968,000  110,000 units).
Budgeted Contribution Margins
Budgeted Budgeted Budgeted
Budgeted Variable Contribution Sales Budgeted Budgeted
Selling Costs per Margin per Volume in Contribution Contribution
Product Price Unit Unit Units Dollars Percent
Palm Pro $379 $182 $197 12,500 $ 2,462,500 19%
Palm CE 269 98 171 37,500 6,412,500 49%
Palm Kid 149 65 84 50,000 4,200,000 32%
100,000 $13,075,000 100%
The budgeted average contribution margin per unit is $130.75 ($13,075,000  100,000 units).

2. Actual Sales Mix

Actual
Sales
Volume in Actual
Product Units Sales Mix
Palm Pro 11,000 10.0% (11,000 ÷ 110,000)
Palm CE 44,000 40.0% (44,000 ÷ 110,000)
Palm Kid 55,000 50.0% (55,000 ÷ 110,000)
110,000 100.0%
Budgeted Sales Mix
Budgeted
Sales
Volume in Budgeted
Product Units Sales Mix
Palm Pro 12,500 12.5% (12,500 ÷ 100,000)
Palm CE 37,500 37.5% (37,500 ÷ 100,000)
Palm Kid 50,000 50.0% (50,000 ÷ 100,000)
100,000 100.0%

14-34
14-32 (Cont'd.)

3. Sales-volume variance:

=  ×

PalmPro (11,000  12,500) × $197 $ 295,500 U

PalmCE (44,000  37,500) × $171 1,111,500 F
PalmKid (55,000  50,000) × $ 84 420,000 F
Total sales-volume variance $1,236,000 F

Sales-mix variance:

= ×  ×

PalmPro = 110,000 × (0.10  0.125) × $197 $541,750 U

PalmCE = 110,000 × (0.40  0.375) × $171 470,250 F
PalmKid = 110,000 × (0.50  0.50) × $ 84 0F
Total sales-mix variance $ 71,500 U

Sales-quantity variance:

=  × ×

PalmPro (110,000  100,000) × 0.125 × $197 $ 246,250 F

PalmCE (110,000  100,000 × 0.375 × $171 641,250 F
PalmKid (110,000  100,000) × 0.50 × $ 84 420,000 F
Total sales-quantity variance $1,307,500 F

14-35
14-32 (Cont’d.)
Solution Exhibit 14-32 presents the sales-volume variance, the sales-mix variance, and the sales-
quantity variance for Palm Pro, Palm CE, and PalmKid and in total for Third Quarter 2004

SOLUTION EXHIBIT 14-32

Sales-Mix and Sales-Quantity Variance Analysis of Aussie Infonautics for Third Quarter
2004

Flexible Budget: Static Budget:

Actual Units of Actual Units of Budgeted Units of
All Products Sold All Products Sold All Products Sold
 Actual Sales Mix  Budgeted Sales Mix  Budgeted Sales Mix
 Budgeted Contribution  Budgeted Contribution  Budgeted Contribution
Margin Per Unit Margin Per Unit Margin Per Unit
Palm Pro 110,000  0.10  $197 =$ 2,167,000 110,000  0.125  $197 =$ 2,708,750 100,000  0.125  $197 =$ 2,462,500
PalmCE 110,000  0.40  $171 = 7,524,000 110,000  0.375  $171 = 7,053,750 100,000  0.375  $171 = 6,412,500
PalmKid 110,000  0.50  $ 84 = 4,620,000 110,000  0.50  $ 84 = 4,620,000 100,000  0.50  $ 84 = 4,200,000
$14,311,000 $14,382,500 $13,075,000
$71,500 U $1,307,500 F
Sales-mix variance Sales-quantity variance
$1,236,000 F
Sales-volume variance

F = favorable effect on operating income; U= unfavorable effect on operating income

4. The following factors help us understand the differences between actual and budgeted
amounts.
 The difference in actual versus budgeted contribution margins was $1,107,000
unfavorable ($11,968,000  $13,075,000). However, the contribution margin from the
PalmCE exceeded budget by $2,079,500 while the contributions from the PalmPro and
the PalmKid were lower than expected and offset this gain. This is attributable to lower
unit sales in the case of PalmPro and lower contribution margins in the case of
PalmKid.
 In percentage terms, the PalmCE accounted for 71% of actual contribution margin
versus a planned 49% contribution margin. However, the PalmPro accounted for 16%
versus planned 19% and the PalmKid accounted for only 13% versus a planned 32%.
 In unit terms (rather than in contribution terms), the PalmKid accounted for 50% of the
sales mix as planned. However, the PalmPro accounted for only 10% versus a
budgeted 12.5% and the PalmCE accounted for 40% versus a planned 37.5%.
 Variance analysis for the PalmPro shows an unfavorable sales-mix variance
outweighing a favorable sales-quantity variance and producing an unfavorable sales-
volume variance. The drop in sales-mix share was far larger than the gain from an
overall greater quantity sold.
 The PalmCE gained both from an increase in share of the sales mix as well as from the
increase in the overall number of units sold.
 The PalmKid maintained sales-mix share at 50%––as a result, the sales-mix variance is
zero. However, PalmKid sales did gain from the overall increase in units sold.

14-36
 14-32 (Cont'd.)

 Overall, there was a favorable total sales-volume variance. However, the large drop in
PalmKid’s contribution margin per unit combined with a decrease in the actual number
of PalmPro units sold as well as a drop in the actual contribution margin per unit below
budget, led to the total contribution margin being much lower than budgeted.

Other factors could be discussed here––for example, it seems that the PalmKid did not achieve
much success with a three digit price point––selling price was budgeted at $149 but dropped to
$102. At the same time, variable costs increased. This could have been due to a marketing push
that did not succeed.

14-33 (20 min.) Market-share and market-size variances

(continuation of 14-32).

1.
Actual Budgeted
Worldwide 500,000 400,000
Aussie Info. 110,000 100,000
Market share 22% 25%

Average contribution margin per unit:

Actual = $108.80 ($11,968,000  110,000)
Budgeted = $130.75 ($13,075,000  100,000)

= 
= 500,000  (0.22 – 0.25)  $130.75
= 500,000  (–0.03)  $130.75
= $1,961,250 U

= 

= (500,000 – 400,000)  0.25  $130.75

= 100,000  0.25  $130.75
= $3,268,750 F

14-37
14-33 (Cont’d.)

Solution Exhibit 14-33 presents the market-share variance, the market-size variance, and the
sales-quantity variance for Third Quarter 2004.

SOLUTION EXHIBIT 14-33

Market-Share and Market-Size Variance Analysis of Aussie Infonautics for Third Quarter
2004

Static Budget:
Actual Market Size Actual Market Size Budgeted Market Size
 Actual Market Share  Budgeted Market Share  Budgeted Market Share
 Budgeted Average  Budgeted Average  Budgeted Average
Contribution Margin Contribution Margin Contribution Margin
Per Unit Per Unit Per Unit
500,000  0.22a  $130.75b 500,000  0.25c  $130.75 b 400,000  0.25c  $130.75b
$14,382,500 $16,343,750 $13,075,000
$1,961,250 U $3,268,750 F
Market-share variance Market-size variance
$1,307,500 F
Sales-quantity variance

F = favorable effect on operating income; U = unfavorable effect on operating income

a
Actual market share: 110,000 units ÷ 500,000 units = 0.22, or 22%
b
Budgeted average contribution margin per unit $13,075,000 ÷ 100,000 units = $130.75 per unit
c
Budgeted market share: 100,000 units ÷ 400,000 units = 0.25, or 25%

2. While the market share declined (from 25% to 22%), the overall increase in the total market
size meant a favorable sales-quantity variance:

Sales-Quantity Variance
$1,307,500 F

Market-Share Variance Market Size Variance

$1,961,250 U $3,268,750 F

14-38
14-33 (Cont’d.)

3. The required actual market size is the budgeted market size, i.e., 400,000 units. This can
easily be seen by setting up the following equation:

= (M – 400,000) × 0.25 × $130.75

When M = 400,000, the market-size variance is $0.

Actual Market-Share Calculation

Again, the answer is the budgeted market share, 25%. By definition, this will
hold irrespective of the actual market size. This can be seen by setting up the
appropriate equation:

Actual Market Size × (M – 25%) × $130.75 = $0

When M = 25%, the market-share variance is $0.

14-39
14-34 (40 min.) Variance analysis, multiple products.

1, 2, and 3. Solution Exhibit 14-34 presents the sales-volume, sales-quantity, and sales-mix
variances for each type of cookie and in total for Debbie's Delight Inc. in August 2003.

The sales-volume variances can also be computed as:

= ×
The sales-volume variances are:
Chocolate chip = (57,600 – 45,000)  $2.00 = $25,200 F
Oatmeal raisin = (18,000 – 25,000)  $2.30 = 16,100 U
Coconut = (9,600 – 10,000)  $2.60 = 1,040 U
White chocolate = (13,200 – 5,000)  $3.00 = 24,600 F
Macadamia nut = (21,600 – 15,000)  $3.10 = 20,460 F
All cookies $53,120 F

The sales-quantity variance can also be computed as :

= 

The sales-quantity variances are:

Chocolate chip = (120,000 – 100,000)  0.45  $2.00 = $18,000 F
Oatmeal raisin = (120,000 – 100,000)  0.25  $2.30 = 11,500 F
Coconut = (120,000 – 100,000)  0.10  $2.60 = 5,200 F
White chocolate = (120,000 – 100,000)  0.05  $3.00 = 3,000 F
Macadamia nut = (120,000 – 100,000)  0.15  $3.10 = 9,300 F
All cookies $47,000 F

The sales-mix variance can also be computed as:

= 

The sales-mix variances are:

Chocolate chip = (0.48 – 0.45)  120,000  $2.00 = $ 7,200 F
Oatmeal raisin = (0.15 – 0.25)  120,000  $2.30 = 27,600 U
Coconut = (0.08 – 0.10)  120,000  $2.60 = 6,240 U
White chocolate = (0.11 – 0.05)  120,000  $3.00 = 21,600 F
Macadamia nut = (0.18 – 0.15)  120,000  $3.10 = 11,160 F
All cookies $ 6,120 F

14-40
14-34 (Cont’d.)

A summary of the variances is:

Sales-Volume Variance
Chocolate chip $25,200 F
Oatmeal raisin 16,100 U
Coconut 1,040 U
White chocolate 24,600 F
Macadamia nut 20,460 F
All cookies $53,120 F

Sales-Mix Variance Sales-Quantity Variance

Chocolate chip $ 7,200 F Chocolate chip $18,000 F
Oatmeal raisin 27,600 U Oatmeal raisin 11,500 F
Coconut 6,240 U Coconut 5,200 F
White chocolate 21,600 F White chocolate 3,000 F
Macadamia nut 11,160 F Macadamia nut 9,300 F
All cookies $ 6,120 F All cookies $47,000 F

4. Debbie's Delight shows a favorable sales-quantity variance because it sold more cookies in
total than was budgeted. Together with the higher quantities, Debbie's also sold more of the
high-contribution margin white chocolate and macadamia nut cookies relative to the budgeted
mix––hence, Debbie's also showed a favorable total sales-mix variance.

14-41
14-34 (Cont’d.)
SOLUTION EXHIBIT 14-34
Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances
FOR DEBBIE'S DELIGHT INC.
Flexible Budget: Static Budget:
Actual Pounds of Actual Pounds of Budgeted Pounds of
All Cookies Sold All Cookies Sold All Cookies Sold
× Actual Sales Mix × Budgeted Sales Mix × Budgeted Sales Mix
× Budgeted Contribution × Budgeted Contribution × Budgeted Contribution
Margin per Pound Margin per Pound Margin per Pound
(1) (2) (3)
Panel A:
Chocolate Chip (120,000 × 0.48a) × $2 (120,000 × 0.45b) × $2 (100,000 × 0.45b) × $2
57,600 × $2 54,000 × $2 45,000 × $2
$115,200 $108,000 $90,000
$7,200 F $18,000 F
Sales-mix variance Sales-quantity variance

$25,200 F
Sales-volume variance

Panel B:
Oatmeal Raisin (120,000 × 0.15c) × $2.30 (120,000 × 0.25d) × $2.30 (100,000 × 0.25d) × $2.30
18,000 × $2.30 30,000 × $2.30 25,000 × $2.30
$41,400 $69,000 $57,500
$27,600 U $11,500 F
Sales-mix variance Sales-quantity variance

$16,100 U
Sales-volume variance

Panel C:
Coconut (120,000 × 0.08e) × $2.60 (120,000 × 0.10f) × $2.60 (100,000 × 0.10f) × $2.60
9,600 × $2.60 12,000 × $2.60 10,000 × $2.60
$24,960 $31,200 $26,000

$6,240 U $5,200 F
Sales-mix variance Sales-quantity variance

$1,040 U
Sales-volume variance

F = favorable effect on operating income; U = unfavorable effect on operating income.

Actual Sales Mix: Budgeted Sales Mix:

aChocolate Chip = 57,600 ÷ 120,000 = 48% bChocolate Chip =   45,000 ÷ 100,000 = 45%
cOatmeal Raisin = 18,000 ÷ 120,000 = 15% dOatmeal Raisin =   25,000 ÷ 100,000 = 25%
eCoconut = 9,600 ÷ 120,000 = 8% f Coconut = 10,000 ÷ 100,000 = 10%

14-42
14-34 (Cont’d.)

SOLUTION EXHIBIT 14-34 (Cont’d.)

Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances
for Debbie's Delight Inc.

Flexible Budget: Static Budget:

Actual Pounds of Actual Pounds of Budgeted Pounds of
All Cookies Sold All Cookies Sold All Cookies Sold
× Actual Sales Mix × Budgeted Sales Mix × Budgeted Sales Mix
× Budgeted Contribution × Budgeted Contribution × Budgeted Contribution
Margin per Pound Margin per Pound Margin per Pound
(1) (2) (3)
Panel D:
White Chocolate (120,000 × 0.11g) × $3.00 (120,000 × 0.05h) × $3.00 (100,000 × 0.05h) × $3.00
13,200 × $3.00 6,000 × $3.00 5,000 × $3.00
$39,600 $18,000 $15,000
$21,600 F $3,000 F
Sales-mix variance Sales-quantity variance

$24,600 F
Sales-volume variance
Panel E:
Macadamia Nut (120,000 × 0.18j) × $3.10 (120,000 × 0.15k) × $3.10 (100,000 × 0.15k) × $3.10
21,600 × $3.10 18,000 × $3.10 15,000 × $3.10
$66,960 $55,800 $46,500
$11,160 F $9,300 F
Sales-mix variance Sales-quantity variance

$20,460 F
Sales-volume variance

Panel F: $288,120l $282,000m $235,000n

All Cookies
$6,120 F $47,000 F
Total sales-mix variance Total sales-quantity variance

$53,120 F
Total
F = favorable effect on operating income; U = unfavorable sales-volume
effect variance
on operating income.

Actual Sales Mix: Budgeted Sales Mix:

gWhite Chocolate = 13,200 ÷ 120,000 = 11% hWhite Chocolate =     5,000 ÷ 100,000 = 5%
jMacadamia Nut = 21,600 ÷ 120,000 = 18% kMacadamia Nut = 15,000 ÷ 100,000 = 15%

l$115,200 + $41,400 + $24,960 m$108,000 + $69,000 + $31,200

+ $39,600 + $66,960 = $288,120 + $18,000 + $55,800 = $282,000

n$90,000 + $57,500 + $26,000

+ $15,000 + $46,500 = $235,000

14-43
14-35 (15 min.) Market-share and market-size variances
(continuation of 14-34).
1.
Actual Budgeted
Chicago Market 960,000 1,000,000
Debbie's Delight 120,000 100,000
Market share 0.125 0.100

The budgeted average contribution margin per unit (also called budgeted contribution margin per
composite unit for budgeted mix) is $2.35:

Budgeted
Contribution Budgeted Budgeted
Margin per Sales Volume Contribution
Pound in Pounds Margin
Chocolate chip $2.00 45,000 $ 90,000
Oatmeal raisin 2.30 25,000 57,500
Coconut 2.60 10,000 26,000
White chocolate 3.00 5,000 15,000
Macadamia nut 3.10 15,000 46,500
All cookies 100,000 $235,000

= = $2.35

= ××

= (960,000 – 1,000,000) × 0.100 × $2.35

= $9,400 U

= ××

= 960,000 × (0.125 – 0.100) × $2.35

= $56,400 F

By increasing its actual market share from the 10% budgeted to the actual 12.50%,
Debbie's Delight has a favorable market-share variance of $56,400. There is a smaller offsetting
unfavorable market-size variance of $9,400 due to the 40,000 unit decline in the Chicago market
(from 1,000,000 budgeted to an actual of 960,000).

14-35 (Cont’d.)

Solution Exhibit 14-35 presents the sales-quantity, market-share, and market-size variances for
Debbie’s Delight Inc. in August 2003.

14-44
SOLUTION EXHIBIT 14-35
Market-Share and Market-Size Variance Analysis of Debbie’s Delight for August 2003

Static Budget:
Actual Market Size Actual Market Size Budgeted Market Size
 Actual Market Share  Budgeted Market Share  Budgeted Market Share
 Budgeted Average  Budgeted Average  Budgeted Average
Contribution Margin Contribution Margin Contribution Margin
Per Unit Per Unit Per Unit
960,000  0.125a  $2.35b 960,000  0.10c  $2.35b 1,000,000  0.10c  $2.35b
$282,000 $225,600 $235,000
$56,400 F $9,400 U
Market-share variance Market-size variance
$47,000 F
Sales-quantity variance

F = favorable effect on operating income; U = unfavorable effect on operating income

a
Actual market share: 120,000 units ÷ 960,000 units = 0.125, or 12.5%
b
Budgeted average contribution margin per unit: $235,000 ÷ 1,000,000 units = $2.35 per unit
c
Budgeted market share: 100,000 units ÷ 1,000,000 units = 0.10, or 10%

An overview of Problems 14-34 and 14-35 is:

Sales-Volume Variance
$53,120 F

Sales-Mix Variance Sales-Quantity Variance

$6,120 F $47,000 F

Market-Share Variance Market-Size Variance

$56,400 F $9,400 U

14-45
14-36 (20–25 min.)Direct materials efficiency, mix and yield variances
(Chapter Appendix).
1 & 2. Actual total quantity of all inputs used and actual input mix percentages for each input
are as follows:
Chemical Actual Quantity Actual Mix Percentage
Echol 24,080 24,080 ÷ 86,000 = 0.28
Protex 15,480 15,480 ÷ 86,000 = 0.18
Benz 36,120 36,120 ÷ 86,000 = 0.42
CT-40 10,320 10,320 ÷ 86,000 = 0.12
Total 86,000 1.00
Budgeted total quantity of all inputs allowed and budgeted input mix percentages for each input
are as follows:
Chemical Budgeted Quantity Budgeted Mix Percentage
Echol 25,200 25,200 ÷ 84,000 = 0.30
Protex 16,800 16,800 ÷ 84,000 = 0.20
Benz 33,600 33,600 ÷ 84,000 = 0.40
CT-40 8,400 8,400 ÷ 84,000 = 0.10
Total 84,000 1.00
Solution Exhibit 14-36 presents the total direct materials efficiency, yield, and mix
variances for August 2003.
Total direct materials efficiency variance can also be computed as:
= ×
Echol = (24,080 – 25,200) × $0.20 = $224 F
Protex = (15,480 – 16,800) × $0.45 = 594 F
Benz = (36,120 – 33,600) × $0.15 = 378 U
CT40 = (10,320 – 8,400) × $0.30 = 576 U
Total direct materials efficiency variance $136 U

The total direct materials yield variance can also be computed as the sum of the direct
materials yield variances for each input:

= × ×

Echol = (86,000 – 84,000) × 0.30 × $0.20 = 2,000 × 0.30 × $0.20 = $120 U

Protex = (86,000 – 84,000) × 0.20 × $0.45 = 2,000 × 0.20 × $0.45 = 180 U
Benz = (86,000 – 84,000) × 0.40 × $0.15 = 2,000 × 0.40 × $0.15 = 120 U
CT40 = (86,000 – 84,000) × 0.10 × $0.30 = 2,000 × 0.10 × $0.30 = 60 U
Total direct materials yield variance $480 U

14-46
 14-36 (Cont'd.)
The total direct materials mix variance can also be computed as the sum of the direct
materials mix variances for each input:

=× ×

Echol = (0.28 – 0.30) × 86,000 × $0.20 = – 0.02 × 86,000 × $0.20 = $344 F

Protex = (0.18 – 0.20) × 86,000 × $0.45 = – 0.02 × 86,000 × $0.45 = 774 F
Benz = (0.42 – 0.40) × 86,000 × $0.15 = 0.02 × 86,000 × $0.15 = 258 U
CT40 = (0.12 – 0.10) × 86,000 × $0.30 = 0.02 × 86,000 × $0.30 = 516 U
Total direct materials mix variance $344 F

3. Energy Products used a larger total quantity of direct materials inputs than budgeted, and
so showed an unfavorable yield variance. The mix variance was favorable because the actual
mix contained more of the cheapest input, Benz, and less of the most costly input, Protex, than
the budgeted mix. The favorable mix variance offset some, but not all, of the unfavorable yield
variance––the overall efficiency variance was unfavorable. Energy Products will find it
profitable to shift to the cheaper mix only if the yield from this cheaper mix can be improved.
Energy Products must also consider the effect on output quality of using the cheaper mix, and the
potential consequences for future revenues.

SOLUTION EXHIBIT 14-36

Columnar Presentation of Direct Materials Efficiency,Yield and Mix Variances
for The Energy Products Company for August 2003

Flexible Budget:
Budgeted Total Quantity of
Actual Total Quantity Actual Total Quantity All Inputs Allowed for Actual
of All Inputs Used of All Inputs Used Output Achieved
× Actual Input Mix × Budgeted Input Mix × Budgeted Input Mix
× Budgeted Price × Budgeted Price × Budgeted Price
(1) (2) (3)
Echol 86,000 × 0.28 × $0.20 = $ 4,816 86,000 × 0.30 × $0.20 = $ 5,160 84,000 × 0.30 ×$0.20 = $ 5,040
Protex 86,000 × 0.18 × $0.45 = 6,966 86,000 × 0.20 × $0.45 = 7,740 84,000 × 0.20 × $0.45 = 7,560
Benz 86,000 × 0.42 × $0.15 = 5,418 86,000 × 0.40 × $0.15 = 5,160 84,000 × 0.40 × $0.15 = 5,040
CT40 86,000 × 0.12 × $0.30 = 3,096 86,000 × 0.10 × $0.30 = 2,580 84,000 × 0.10 × $0.30 = 2,520
$20,296 $20,640 $20,160

$344 F $480 U
Total mix variance Total yield variance
$136 U
Total efficiency variance

F = favorable effect on operating income; U = unfavorable effect on operating income

14-47
14-37 (35 min.) Direct materials price, efficiency, mix and yield variances
(Chapter Appendix).

1. Solution Exhibit 14-37A presents the total price variance ($3,100F), the total efficiency
variance ($2,560U), and the total flexible-budget variance ($540F).

Total direct materials price variance can also be computed as:

= ×

Tolman = ($0.28 – $0.30) × 62,000 = $1,240 F

Golden Delicious = ($0.26 – $0.26) × 155,000 = 0
Ribston = ($0.20 – $0.22) × 93,000 = 1,860 F
Total direct materials price variance $3,100 F

Total direct materials efficiency variance can also be computed as:

= ×

Tolman = ( 62,000 – 45,000) × $0.30 = $5,100 U

Golden Delicious = (155,000 – 180,000) × $0.26 = 6,500 F
Ribston = ( 93,000 – 75,000) × $0.22 = 3,960 U
Total direct materials efficiency variance $2,560 U

SOLUTION EXHIBIT 14-37A

Columnar Presentation of Direct Materials Price and Efficiency Variances for Greenwood Inc.
for November 2003

Flexible Budget
Actual Costs (Budgeted Inputs
Incurred Allowed for Actual
(Actual Inputs Actual Input Outputs Achieved
× Actual Prices) × Budgeted Prices × Budgeted Prices)
(1) (2) (3)
Tolman 62,000 × $0.28 = $17,360 62,000 × $0.30 = $18,600 45,000 × $0.30 = $13,500
Golden Delicious 155,000 × $0.26 = 40,300 155,000 × $0.26 = 40,300 180,000 × $0.26 = 46,800
Ribston 93,000 × $0.20 = 18,600 93,000 × $0.22 = 20,460 75,000 × $0.22 = 16,500
$76,260 $79,360 $76,800

$3,100 F $2,560 U
Total price variance Total efficiency variance
$540 F
Total flexible-budget variance
F = favorable effect on operating income; U = unfavorable effect on operating income

14-48
 14-37 (Cont'd.)
2. Solution Exhibit 14-37B presents the total direct materials yield and mix variances for
Greenwood Inc. for November 2003.
The total direct materials yield variance can also be computed as the sum of the
direct materials yield variances for each input:

= × ×
Tolman = (310,000 – 300,000) × 0.15 × $0.30 = 10,000 × 0.15 × $0.30 = $ 450 U
Golden Delicious = (310,000 – 300,000) × 0.60 × $0.26 = 10,000 × 0.60 × $0.26 = 1,560 U
Ribston = (310,000 – 300,000) × 0.25 × $0.22 = 10,000 × 0.25 × $0.22 = 550 U
Total direct materials yield variance $2,560 U
The total direct materials mix variance can also be computed as the sum of the direct materials
mix variances for each input:
=××
Tolman = (0.20 – 0.15) × 310,000 × $0.30 = 0.05 × 310,000 × $0.30 = $4,650 U
Golden Delicious = (0.50 – 0.60) × 310,000 × $0.26 = – 0.10 × 310,000 × $0.26 = 8,060 F
Ribston = (0.30 – 0.25) × 310,000 × $0.22 = 0.05 × 310,000 × $0.22 = 3,410 U
Total direct materials mix variance $ 0U
3. Greenwood paid less for Tolman and Ribston apples and, so, had a favorable direct
materials price variance of $3,100. It also had an unfavorable efficiency variance of $2,560.
Greenwood would need to evaluate if these were unrelated events or if the lower price resulted
from the purchase of apples of poorer quality that affected efficiency. The net effect in this case
from a cost standpoint was favorable––the savings in price being greater than the loss in
efficiency. Of course, if the applesauce is of poorer quality, Greenwood must also evaluate the
potential effects on current and future revenues that have not been considered in the variances
described in requirements 1 and 2.
The unfavorable efficiency variance is entirely attributable to an unfavorable yield. The
actual mix does deviate from the budgeted mix but at the budgeted prices, the greater quantity of
Tolman and Ribston apples used in the actual mix exactly offsets the fewer Golden Delicious
apples used. Again, management should evaluate the reasons for the unfavorable yield variance.
Is it due to poor quality Tolman and Ribston apples (recall from requirement 1 that these apples
were acquired at a price lower than the standard price)? Is it due to the change in mix (recall
that the mix used is different from the budgeted mix, even though the mix variance is $0)?
Isolating the reasons can lead management to take the necessary corrective actions.

14-49
14-37 (Cont'd.)

SOLUTION EXHIBIT 14-37B

Columnar Presentation of Direct Materials Yield and Mix Variances
for Greenwood Inc. for November 2003

Flexible Budget:
Budgeted Total Quantity of All
Actual Total Quantity Actual Total Quantity Inputs Allowed for Actual
of All Inputs Used of All Inputs Used Output Achieved ×
× Actual Input Mix × Budgeted Input Mix Budgeted Input Mix
× Budgeted Prices × Budgeted Prices × Budgeted Prices
(1) (2) (3)

Tolman 310,000 × 0.20 × $0.30= $18,600 310,000 × 0.15 × $0.30 = $13,950 300,000 × 0.15 × $0.30 = $13,500
Delicious 310,000 × 0.50 × $0.26 = 40,300 310,000 × 0.60 × $0.26 = 48,360 300,000 × 0.60 × $0.26 = 46,800
Ribston 310,000 × 0.30 × $0.22 = 20,460 310,000 × 0.25 × $0.22 = 17,050 300,000 × 0.25 × $0.22 = 16,500
$79,360 $79,360 $76,800
0 $2,560 U
Total mix variance Total yield variance
$2,560 U
Total efficiency variance
F = favorable effect on operating income; U = unfavorable effect on operating income.

14-38 (15–20 min.) Customer profitability, responsibility for

environmental clean-up, ethics.
1. Customer-profitability analysis examines how individual customers differ in their
profitability. The revenues and costs of each customer can be estimated with varying degrees of
accuracy. Revenues of IF typically would be known at the time of sale. Many costs also would
be known, e.g., the cost of materials used to manufacture the fluids sold to each customer. A
major area of uncertainty is future costs associated with obligations arising from the sale. There
are several issues here:

a. Uncertainty as to the existence and extent of legal liability. Each customer has primary
responsibility to dispose of its own toxic waste. However, under some U.S. laws (such as the
"Superfund" laws), suppliers to a company may be partially liable for disposal of toxic material.
Papandopolis needs to determine the extent of IF's liability. It would be necessary to seek legal
guidance on this issue.

b. Uncertainty as to when the liability will occur. The further in the future, the lower the
amount of the liability (assuming discounting for the time-value of money occurs.)

c. Uncertainty as to the amount of the liability, given that the liability exists and the date of
the liability can be identified. Papandopolis faces major difficulties here––see the answer to
requirement 2.

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14-38 (Cont'd.)
Many companies argue that uncertainties related to (a), (b), and (c) make the inclusion of
"hard-dollar estimates meaningless." However, at a minimum, a contingent liability should be
recognized and included in the internal customer-profitability reports.

2. Papandopolis' controller may believe that if estimates of future possible legal exposure
are sufficiently uncertain, then they should not be recorded. His concern about "smoking guns"
may have a very genuine basis––that is, if litigation arises, third parties may misrepresent
Papandopolis' concerns to the detriment of IF. Any written comments that she makes may
surface 5 or 10 years later and be interpreted as "widespread knowledge" within IF that they have
responsibility for large amounts of environmental clean-up.
Given this background, Papandopolis still has the responsibility to prepare a report in an
objective and competent way. Moreover, she has visited 10 customer sites and has details as to
their toxic-waste handling procedures. If Acme goes bankrupt and has no liability insurance, one
of the "deep pockets" available to meet toxic waste handling costs is likely to be IF. At a
minimum, she should report the likely bankruptcy and the existence of IF's contingent liability
for toxic-waste clean-up in her report. Whether she quantifies this contingent liability is a more
difficult question. Papandopolis has limited information available to make a meaningful
quantification. She is not an employee of Acme Metal and has no information about Acme's
liability insurance. Moreover, she does not know what other parties (such as other suppliers) are
also jointly liable to pay Acme's clean-up costs.
The appropriate course appears to highlight the contingent liability but to not attempt to
quantify it.

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14-39 (40–60 min.) Customer profitability, credit card operations.
1. Customer
A B C D
Customer revenues
Annual fee $ 50 $ 0 $ 50 $ 0
Merchant paymentsa 1,600 520 680 160
Interest spreadb 540 0 180 9
Total 2,190 520 910 169
Customer costs
Annual maintenance costs
108 108 108 108
Bad debt provisionc 400 130 170 40
Transaction costs d 400 260 136 100
Customer inquiries e 30 60 40 10
Card replacementsf 0 240 120 0
Total 938 798 574 258
Customer operating income $1,252 $(278) $336 $ (89)
a 2% × $80,000; $26,000; $34,000; $8,000
b 9% × $6,000; $0; $2,000; $100
c 0.5% × $80,000; $26,000; $34,000; $8,000
d $0.50 × 800; 520; 272; 200
e $5 × 6; 12; 8; 2
f $120 × 0; 2; 1; 0

Note: The above analysis uses the average 0.5% bad debt provision. Bay Bank may want to
adjust individual customer-profitability reports at a subsequent date to reflect actual bad debt
experience.
2. Profitable Unprofitable
Customers Customers
Revenues
Fees Pays fee Fee waived
Merchant payments High billings and high billings Low billings and low billings
per transaction per transaction
Interest spread High outstanding balance Pays on time and has no
outstanding balance
Costs
Bad debt "provision" Pays account Defaults on account
Transaction costs Low number of transactions & High number of transactions &
high billings per low billings per transaction
transaction
Customer inquiries Zero or few inquiries Many inquiries
Card replacement No replacements Multiple replacements

14-52
14-39 (Cont'd.)

3. The pros of charging for individual services include:

a. Additional source of revenues. If Bay Bank is able to charge more than the cost of each
service, it may prefer that customers be prolific users of its services.
b. If Bay Bank is not able to charge the "full cost" for each service, the charge may reduce
customer usage (thus reducing the losses associated with providing services at below cost). For
example, Customer B may make fewer inquiries about his or her balance.

The cons of charging for individual services include:

a. May cause customers to drop card or decrease its usage vis-à-vis competitors’ cards that
have zero or minimal charges.
b. May attract much negative publicity from consumer groups who target companies such
as banks and credit card companies.

4. Factors to consider include:

a. The growth potential of individual customers. Some low-volume credit customers (such
as students) may be high-volume users in the medium run.
b. The costs saved by discontinuing low-volume credit card customers. Many costs may be
relatively "fixed" and may not be eliminated by dropping customers.
c. The publicity Bay Bank may attract from discontinuing these customers. There is the
potential for much negative publicity from such decisions.
d. Alternatives available to discontinuance, e.g., adopt individual service charges.

5. The pros of providing the service at Lucky Roller include:

a. Potential increased profitability due to higher usage by Freedom Card holders at Lucky
Roller.
b. Potential increased attraction to current and future Freedom Card holders. As a general
rule, the more services available, the more attractive the card.

Possible cons include:

a. Potential bad debts. While money advances in general may have been profitable, it is
possible that some specific money advance outlets may be unprofitable. Verdolini should
examine this issue in more detail to determine if Bay Bank has made money advances at other
gambling venues.
b Potential negative publicity from media stories arguing that the Bay Bank is helping
gamblers to lose money. These stories often focus on individuals with gambling addictions.
c. Ethical position of the Bay Bank regarding gambling. Providing a money advance
service at the casino may conflict with the ethical beliefs of senior management or the Board of
Directors.

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Chapter 14 Internet Exercise

The Internet exercise is available to students only on the Prentice Hall Companion Website
www.prenhall.com/horngren. Students can click on Cost Accounting, 11th ed., and access the
Internet Exercise for the chapter, which links to the Web site of a company or organization. The
Internet Exercise on the Web will be updated periodically so that it is current with the latest
information available on the subject organization's Web site. A printout copy of the Internet
exercise for this chapter as of early 2002 appears below.
The solution to the Internet exercise, which will also be updated periodically, is available
to instructors from the Companion Website's faculty view. To access the solution, click on Cost
Accounting, 11th ed., Faculty link, and then register once to obtain your password through the
online form. After the initial registration, you will have a personal login ID and password to use
to log in. A printout of the solution to the Internet exercise for this chapter as of early 2002
follows. The exercise and solution provide instructors with an idea of the content of the Internet
exercise for this chapter.

Internet Exercise
In an effort to refocus its business and improve revenue growth Hewlett-Packard (HP) spun off
its test and measurement business through a stock dividend to its shareholders. The newly
formed company, Agilent Technologies, reported $757 million in earnings on revenues of $9.4
billion in its first year of operations. Prior to the spinoff, HP accounted for Agilent as a separate
business segment.
1a. Go to Hewlett-Packard’s investor relations Web page, www.hp.com/hpinfo/investor/, click
on the "SEC filings" link, and open the 10-K report filed on 1/27/00. This is HP's 1999
annual report. Scroll down to the segment information on page 49. What types of services
and expense are shared between HP's four business segments?

1b. What is HP's rationale for sharing expenses and services between business segments?

1c. How does HP allocate the cost of shared expenses and services?

2. Why might HP face problems if it bases management compensation on the profitability of

individual business segments?
3. Go to Agilent Technologies’ Investor Relations Web page, www.investor.agilent.com/,
click on the "Annual Report" link, and open the 2000 annual report. Scroll down to
footnote 14, "Transactions with Hewlett-Packard," on page 40.
3a. What were Agilent's sales to HP for the period from November 1, 1999 to June 2, 2000?
3b. What were Agilent's purchases from HP in the period from November 1, 1999 through
June 2, 2000?
4a. Prior to the spin-off, shared expenses were allocated between HP's business segments. How
have Agilent and HP handled shared expenses since the spin-off?
4b. What was the value of shared services for November 1, 1999, to June 2, 2000?

14-54
Internet Exercise (Cont’d.)

4c. What is the additional implication of shared expenses between Agilent and HP now that
they are independent companies?

4d. Scroll down the "Transactions with Hewlett-Packard" footnote. What other separation
agreements have Agilent and HP entered into?

Solution to Internet Exercise

1a. A significant portion of the segments' expenses arise from shared services and
infrastructure that HP has historically provided to the segments in order to realize
economies of scale and to use resources efficiently. These expenses include costs of
centralized research and development, legal, accounting, employee benefits, real estate,
insurance services, information technology services, treasury and other corporate and
infrastructure costs.

1b. HP has historically provided services to the segments in order to realize economies of scale
and to use resources efficiently.

1c. These allocations have been determined on bases that HP considers to be a reasonable
reflection of the utilization of services provided to or benefits received by the segments. If
costs were specifically identified to each segment, amounts could vary from the allocated
cost.

2. HP may face problems if it bases compensation on the profitability of individual business

segments. Since the cost of shared expenses are not bargained for in an arms length
transaction, managers may argue about their reasonableness. Managers should be
evaluated on the basis of controllable costs and revenues or perhaps the performance of the
entire organization.

3a. Agilent's sales to HP for the period November 1, 1999, to June 2, 2000, were $341 million,

3b. Purchases from HP were approximately $122 million.

4a. Agilent and HP entered into interim service level agreements, for various services,
including information technology, financial, accounting, building, and legal services.
These services are generally being provided for fees equal to the actual direct and indirect
costs of providing the services plus 5%.

4b. Agilent received $267 million from HP and HP received $95 million in services from
Agilent.

4c. In addition to tax implications, there will be tax implications for the shareholder of each
company. Any misallocation of expenses will affect each company's cash flow, earnings,
and share price.

14-55
Internet Exercise (Cont’d.)
5. Agilent and HP have entered into separation agreements covering:
 General Assignment and Assumption of Assets and Liabilities
 Indemnification and Insurance Matters
 Employee Matters
 Tax Sharing
 Real Estate Matters
 Information Technology Sharing
 Intellectual Property
 Environmental Matters
Chapter 14 Video Case
The video case can be discussed using only the case writeup in the chapter. Alternatively,
instructors can have students view the videotape of the company that is the subject of the case.
The videotape can be obtained by contacting your Prentice Hall representative. The case
questions challenge students to apply the concepts learned in the chapter to a specific business
situation.
NANTUCKET NECTARS: COST ALLOCATION VIDEO CASE
1. The types of economic decisions faced by Nantucket Nectars might include deciding which
new juice flavors to introduce to the market, which to discontinue, and how many new flavors the
market can absorb. In determining which flavors are most profitable, Nantucket Nectars would need
to allocate the costs of the Mobile Juice Guy Team to the different flavors, based perhaps on the time
the Mobile Team spends promoting the different flavors and the samples and coupons it distributes.
The company may also be interested in determining the profitability of its different regions. To
calculate this profitability, the costs of the Mobile Juice Guy Team would need to be allocated to the
different regions. The costs of the Mobile Team are: van depreciation, insurance, full-time employee
salaries, depreciation of display tables and banners, travel costs (lodging, meals, vehicle gas, and
maintenance), coupons, juice beverages, and sample cups. The costs that would go into the fixed-
cost subpool are: depreciation on the full-size van, depreciation on the banners and display tables,
insurance on the van and equipment, and salaries for the four Mobile Team members. The variable
subpool costs would include coupons, bottled juice flavors dispensed, sample cups, and travel
expenses for the team. The most appropriate activity base used for allocating the subpool costs would
be the time spent in each region, including travel days to the region.

2. Nantucket Nectars could motivate regional sales managers to use more of the Mobile Juice
Guy Team by not allocating the full cost of the Team to regional managers. Such a system may,
however, lead regional managers to overuse the Mobile Team.

3. Nantucket Nectars would need to cost-justify the Mobile Team’s operations to be sure the
company is getting the necessary sales and profitability boost expected for this set of expenditures.
This requires the company to estimate the sales and profitability attributable to the Mobile Team.

4. Although the company is privately held, it still must produce internal financial reports for use
by management and external reports for tax purposes. The company also has a majority shareholder,
Ocean Spray, for whom reports must be generated. Cost allocation can help with appropriately
valuing inventory and assets associated with operations.

14-56