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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

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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

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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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OutputsInputs

Basic Activity View

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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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Just in time

Basic Activity View

Outputs

INPUTS

Input/Output

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Input/Output Relationships

INPUTS OUTPUTS

Yield or Productivity

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 @ $4 + 6 units @ $6 = $52

Contribution margin at standard

for planned sales of 10 units:

(10 units @ $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 $-2.0UCM 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 @ $4 + 5 units @ $5 + 2 units @ $6

= $ 12 + $ 25 + $ 12 = $ 49

Actual units at standard margin:

4 units @ $4 + 5 units @ $5 + 1 units @ $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) @ $4.90 = $4.90 Fwhere 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 - .3[11]) x ($4 - 4.9) = 0.7($-0.9)

So (5 - .5[11]) x ($5 - 4.9) =-0.5($ 0.1)

Dx (2 - .2[11]) 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 @ $4 + 5 @ $5 + 2 @ $ 6

= $ 16 + $ 25 + $ 12

= $53

Planned contribution margin:

= 10 units @ $ 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!