Agenda Today

1
Agenda Today

• Refine some points from last Wednesday
• Review examples of the results of your homework
  assignment
• Make some observations
• Clarify our views of the activity paradigm
• Discuss efficiency effectiveness
• Talk about standard costs of activities

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Differential Profitability View

• Revenue 1,000,000
• Variable expenses 300,000
• Contribution margin 700,000
• Nonvariable expenses 400,000
• Income from operations 300,000
• Income taxes 90,000
• Net income 210,000

3
Profitability - Internal Report

• Revenue 1,000,000
• Variable production cost 300,000
• Contrib.margin on production 700,000
• Nonvariable mfg. cost 400,000
• Gross margin 300,000
• Selling admin. expenses 120,000
• Income from operations 180,000
• Income taxes 60,000
• Net income 120,000

4
Profitability - External Report

• Revenue 1,000,000
• Cost of goods sold 700,000
• Gross margin 300,000
• Selling admin. expenses 120,000
• Income from operations 180,000
• Income taxes 60,000
• Net income 120,000

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Basic Activity View
Activity
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Activity Terminology

• Statistics represent the numeric values assigned
  to the metrics for a period.
• Data sources are the primary or secondary sources
  of the statistics.

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Efficiency in Accounting

• In accounting we use cost standards, flexible
  budgets and profitability measures to evaluate
  efficiency. These standards relate the work done
  to the cost incurred to achieve that work.
  Physical measures are useful, but the ultimate
  measures include profitability.
• We may measure other operating variables because
  we believe they relate to profitability in the
  longer run.

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Basic Activity View
Just in time
INPUTS
Outputs
Input/Output
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Input/Output Relationships
Yield or Productivity
INPUTS
OUTPUTS
Efficiency
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Sales Mix and Volume

• Just as we have focused on contribution margin to
  make product mix and other differential
  profitability decisions, we are going to focus on
  contribution margins in evaluating the results of
  operations. In anticipation of what comes later,
  let us consider the idea of sales mix and volume
  variances.

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Sales Mix Volume

• Planned Sales Mix
• Total Plain Deluxe
• Sales price 11 10 12
• Variable cost 6 6 6
• Contribution margin 5 4 6
• Planned mix 50 50

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Sales Mix Volume

• Suppose actual sales were 10 units
• 4 units of Plain, and 6 units of Deluxe.
• Quantity Contribution
• Actual - Plan UCM - ACM
• P (4 - 5 units) x (4 - 5) 1
• D (6 - 5 units) x (6 - 5) 1
• Total mix variance 2

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Observe

• The effect is easy to see because we sold one
  fewer of the low margin, plain model, and one
  more of the deluxe model for an increase in
  contribution margin of 2. There was a clear
  trade-off.

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Calculated another way--

• Contribution margin at standard for actual sales
  of 10 units
• (4 units _at_ 4 6 units _at_ 6 52
• Contribution margin at standard
• for planned sales of 10 units
• (10 units _at_ 5 weighted avg.) 50
• Total mix variance 2

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More Complicated

• Next, let us consider a more complicated case
  involving three products and a different sales
  mix than planned.

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More complicated example

• Plain So-So Deluxe
• Price 10 11 12
• Variable cost 6 6 6
• Contribution 4 5 6
• Planned mix 30 50 20
• ACM 0.3( 4) 0.5( 5) 0.2( 6)
• 1.2 2.5 1.2 4.9/unit

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More Complicated

• Actual sales 4 Plain, 5 SoSo, 1 Deluxe
• (Actual - Plan) x (UCM - ACM)
• PL (4 - 3 u) x (4 - 4.9) - 0.9
• So (5 - 5 u) x (5 - 4.9) 0
• Dx (1 - 2 u) x (6 - 4.9) - 1.1
• Total mix variance -2.0
• UCM is unit contribution marg., ACM is average

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Alternative Formulation

• Item (Actual - Standard) x UCM
• Plain (4 - 3) x 4 4
• SoSo (5 - 5) x 5 0
• Deluxe (1 - 2) x 6 - 6
• Total mix variance - 2
• UCM is unit contribution margin

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Comparing Totals

• Planned contribution margin
• 3 units _at_ 4 5 units _at_ 5 2 units _at_ 6
• 12 25 12 49
• Actual units at standard margin
• 4 units _at_ 4 5 units _at_ 5 1 units _at_ 6
• 16 25 6 47
• Total variance Actual - Plan -2

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Still More Complicated

• Next, let us consider the case in which both the
  total volume and the mix of product sales differ
  from plan.

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Volume Variance

• If we sell more units than planned, then there is
  an overall volume effect in addition to a
  possible mix effect. We could have one without
  the other, except at very low volume levels
• Volume variance (QA - QP)ACM
• (11 u - 10 u) _at_ 4.90 4.90 F
• where QA is actual volume, QP is planned volume,
  and
• ACM is the weighted-average planned contrib.
  margin.

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More Complicated

• Actual sales 4 Plain, 5 SoSo, 2 Deluxe
• (Actual - Plan) x (CM - ACM)
• PL (4 - .311) x (4 - 4.9) 0.7(-0.9)
• So (5 - .511) x (5 - 4.9) -0.5( 0.1)
• Dx (2 - .211) x (6 - 4.9) -0.2( 1.1
• Total mix variance -0.90 U
• Total variance 4.90 - 0.90 4.00

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Compare the Totals for Variance

• Actual volume at standard cm
• 4 _at_ 4 5 _at_ 5 2 _at_ 6
• 16 25 12
• 53
• Planned contribution margin
• 10 units _at_ 4.90
• 49
• Variance 53 - 49, or 4 Favorable

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Under What Conditions.....?

• When a mix variance makes sense
• Products are substitutes in the eyes of
  customers.
• There are one or more constraints that force
  trade-offs in the production, distribution or
  sales of products and services.

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Interpreting the Mix Variance

• Under most conditions, only the total mix
  variance makes sense as a measure of the over-all
  impact of a change in sales mix. If one were
  looking for a particular shift in mix, then one
  can look at the variances for individual
  products, but the variances do not reveal exactly
  which products are being substituted for which.
  At best, variances can only confirm hypotheses.

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• Break for it!