Chapter 14

What criteria might managers use to guide cost-allocation decisions? Which are the dominant criteria?

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.

Explain why a favorable sales-quantity variance occurs.

A favorable sales-quantity variance arises because the actual units of all products sold exceed the budgeted units of all products sold.

What information does the whale curve provide?

Charting cumulative profits by customer or product type generates a whale curve. This provides information on the profitability of customers and clearly differentiates the most profitable from the least profitable.

How can a company track the extent of price discounting on a customer-by-customer basis?

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

Why is customer-profitability analysis an important topic for managers?

Customer profitability analysis highlights for 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.

"A company should not allocate costs that are fixed in the short run to customers." Do you agree?

Disagree. A company will frequently allocate costs that are fixed in the short run to customers to determine long-run profitability of customers. In the long run, a company must ensure that the revenues received from a customer exceed the total resources consumed to support the customer, regardless of whether these costs are variable or fixed in the short run. For short-run decisions, however, costs that are fixed in the short run may often be irrelevant.

"I'm going to focus on the customers of my business and leave cost-allocation issues to my accountant." Do you agree with this comment by a division president? Explain.

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.

"Once a company allocates corporate costs to divisions, these costs should not be reallocated to the indirect-cost pools of the division." Do you agree?

Disagree. If corporate costs allocated to a division can be reallocated to the indirect cost pools of the division on the basis of a logical cause-and-effect relationship, then it is in fact preferable to do so—this will result in fewer division-indirect-cost pools and a more cost-effective cost allocation system. This reallocation of allocated corporate costs should only be done if the allocation base used for the division indirect cost pool has the same cause-and-effect relationship with every cost in that indirect cost pool, including the reallocated corporate cost.

"A company should not allocate all of its corporate costs to its divisions." Do you agree?

Disagree. In general, companies have three choices regarding the allocation of corporate costs to divisions: allocate all corporate costs, allocate some corporate costs (those "controllable" by the divisions), and allocate none of the corporate costs. Which one of these is appropriate depends on several factors: the composition of corporate costs, the purpose of the costing exercise, and the time horizon, to name a few. For example, one can easily justify allocating all corporate costs when they are closely related to the running of the divisions and when the purpose of costing is, say, pricing products or motivating managers to consume corporate resources judiciously.

"A customer-profitability profile highlights those customers a company should drop to improve profitability." Do you agree?

No. A customer profitability profile highlights differences in the 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.

How can the sales-quantity variance be decomposed further?

The sales-quantity variance can be decomposed into (a) a market-size variance (which arises when the actual total market size in units is different from the budgeted market size in units) and (b) a market share variance (which arises when the actual market share of a company is different from its budgeted market share). Both variances use the budgeted average contribution margin per unit.

How can the concept of a composite unit be used to explain why an unfavorable total sales-mix variance of contribution margin occurs?

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.

Show how managers can gain insight into the causes of a sales-volume variance by subdividing the components of this variance.

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.

How should a company decide on the number of cost pools it should use to allocate costs to divisions, channels, and customers?

When allocating costs to divisions, channels, and customers, companies must construct cost pools that are, to the extent possible, homogeneous, so that all costs in the cost pool have the same or a similar cause-and-effect or benefits-received relationship with the cost-allocation base. If each cost category has a cause-and-effect or benefits-received relationship with a different cost-allocation base, the company should maintain separate cost pools for each of these costs. Determining homogeneous cost pools requires judgment and should be revisited on a regular basis.

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 Provalue Division's wholesale distribution channel.

Customer batch-level costs

costs of activities that are related to a group of units (computers) sold to a customer. Examples are costs incurred to process orders or to make deliveries.

Customer output-unit-level costs

costs of activities to sell each unit (computer) to a customer. An example is product handling costs of each computer sold.

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.

Division-sustaining costs

costs of division activities that cannot be traced to individual customers or distribution channels. An example is the salary of the Pro-value Division manager.

Five categories in a customer cost hierarchy are identified in the chapter. The examples given relate to the Provalue Division of Astel Computers used in the chapter:

● Customer output-unit-level costs ● Customer batch-level costs ● Customer-sustaining costs ● Distribution-channel costs ● Division-sustaining costs