Revenue Allocations, Sales

Variances, and Customer-

Profitability Analysis

Chapter 15/16
P633-640, 680-683,P614-623
 Learning Objectives
1. Discuss Revenue allocations issues
2. Analyze sales volume variance including
sales-mix and sales-quantity variances and
their interpretation
3. Analyze sales-quantity variance by
calculating market-share and market-size
variances and their interpretations
4 Prepare Customer revenue /cost and
profitability Analysis
1.Revenue allocation issues
 Revenue allocation occurs when
revenues are related to a particular
revenue object, but cannot be traced
to it in an economically feasible way.
 Examples of revenue objects includes
– Products
– Customers
– Divisions
 Revenues and Bundled
Products
 A bundled product is a package of two or
more products (or services) sold for a
single price.(suite sales)
 The individual components of the bundle
also may be sold as separate items at
their own “stand-alone” prices.
 The single price for a bundled product is
typically less than the sum of the prices of
the individual products sold separately.
Revenue Allocation Methods
 SAR Languages Institute buys English
language software programs locally
and then sells them in China and
South East Asia.
 SAR sells the following programs:
Grammar, Translation, and
Composition
 These programs are offered stand-
alone or in a bundle.
Revenue Allocation Methods
 Stand-alone Price
 Grammar $255
 Translation $ 85
 Composition $185
 Purchasing these software programs cost
SAR the following:
 Grammar $180
 Translation $ 45
 Composition $ 95
 Revenue Allocation Methods

Bundle (Suites)
Price Grammar +
Translation $290 Grammar +
Composition $350 Grammar +
Translation+ Composition $410
 The three main revenue allocation methods
are:
1. The stand-alone method
2. The incremental method
Stand-Alone Revenue Allocation
Method
 The stand-alone revenue allocation method
uses product-specific information on the
bundle of products as the weights to
allocate the bundled revenues to the
individual products.
 There are three types of weights for the
stand-alone revenue allocation method.
1 Selling prices
2 Unit costs
3 Physical units
 Stand-Alone Revenue Allocation
Method
 Consider the Grammar and Translation suite,
which sells for $290 per day.
 How much weight should SAR Languages
Institute assign to each item?
Selling prices: The individual selling prices are
$255 for Grammar and $85 for Translation.

Grammar: $255 ÷ $340 = 0.75

0.75 × $290 = $217.50

Translation: $85 ÷ $340 = 0.25
Stand-Alone Revenue Allocation
Method

 Unit costs: This method uses the costs

of the individual products to determine
the weights for the revenue
allocations.
 Grammar: $180 ÷ $225 = 0.80
0.80 × $290 = $232
Translation: $45 ÷ $225 =
0.20 0.20 × $290 =
$58
Stand-Alone Revenue Allocation
Method

 Physical units: This method gives each

product unit in the suite the same
weight when allocating suite revenue
to individual products.
 With two products in the suite, each
product is allocated 50% of suite
revenues. 1 ÷ (1 + 1) = 0.50
0.50 × $290 =
$145
Stand-Alone Revenue Allocation
Method

Revenue Allocation
Weights Grammar
Translation Selling prices $217.50
$ 72.50
Unit costs 232.00 58.00
Physical units 145.00 145.00
Stand-Alone Revenue Allocation
Method

 The selling price method has the

advantage that it represents a good
indicator of the minimum benefits
customers receive from those products.
 Physical units methods not frequently used
 Incremental Revenue Allocation
Method
 The incremental revenue allocation method ranks
the individual products in a bundle according to
criteria determined by management.
 This ranking is used to allocate the bundled
revenues to the individual products.
 The first-ranked product is termed the primary
product in the bundle.
 The second-ranked product is termed the first
incremental product.
 The third-ranked product in the second incremental
product, and so on.
Incremental Revenue Allocation
Method

 Assume that Grammar is designated

as the primary product.
 If the suite selling price exceeds the
stand-alone price of the primary
product, the primary product is
allocated 100% of its stand-alone
revenue.
 Incremental Revenue
Allocation Method

Revenue
Product Allocated
Grammar $255
Translation (remaining) $290-$255= 35
Total revenue allocate
$290
Shapley Value Method
 Under the Shapley value method the
revenue allocated represents an
average of the revenue that would
have been received if each product or
service were ranked as both the
primary party and the incremental
party
 Shapley Value Method

If Grammar is primary product

Revenue
Product Allocated
Grammar $255
Translation 290-255= 35

Total revenue allocated $290

 Shapley Value Method
If Translation is the primary product
Revenue
Product Allocated
Translation $85
Grammar ($290 – $85)= 205

Total revenue allocated $290

Shapley Value Method
 Revenue allocation under the Shapley
value method, based on the data from
the incremental rankings above is:
 Grammar ($255+$205)/2 = $230
 Translation ($35+ $85)/2 = $60
 Total $290
 2.Sales-Volume Variance
Components

 The following information relates to SAR

Languages Institute budget for the year 2021.
 Product Grammar Trans. Comp.
Selling price per unit
259 $87 $185
Variable cost 189 50
95 Contribution

 margin per unit $ 70 $37 $ 90

Sales-Volume Variance
Components
Product Grammar Trans. Comp.
Contr. margin 70 37 90
× No. of units 3,185 980 735
= Total $222,950 $36,260 $66,150
Sales mix
based on units 65% 20% 15%
Total budgeted contribution margin = $325,360
 Sales-Volume Variance
Components

 The following are the actual results for SAR

Languages for the year 2021
 Product Grammar Trans. Comp.
 Selling price/unit $255 $85 $185
Variable cost 180
45 95 Contribution

 margin per unit $ 75 $40 $ 90

Sales-Volume Variance
Components

Product Grammar Trans. Comp.

Contr. margin 75 40 90
× No. of units 2,880 990 630
= Total $216,000 $39,600 $56,700
Sales mix
based on units 64% 22% 14%
Total actual contribution margin = $312,300
Static-Budget Variance
 The static-budget variance is the
difference between an actual result
and a budgeted amount in the static
budget.
 What is SAR Languages Institute’s
static-budget variance using the
figures for the contribution margin?
 Static-Budget Variance

Static- Static-
Actual budget budget
Product results amount variance
Grammar $216,000 $222,950 $ 6,950
U
Translation 39,600 36,260 3,340
F
Composition 56,700 66,150 9,450 U
Total $312,300 $325,360 $13,060
U
(Appendix 1)
Flexible-Budget Variance
 The flexible-budget variance is the
difference between an actual result
and the flexible-budget amount based
on the level of output actually achieved
in the budget period.
 Flexible-Budget Variance
 Actual results = Actual contribution margin per
unit × Actual unit volume
 Actual Actual
contribution unit Actual
Product margin/unit volume results
Grammar $75 2,880 $216,000
Translation $40 990
$ 39,600 Composition $90 630
$ 56,700
 Flexible-Budget Variance
 Flexible-budget amount = Budgeted
contribution margin/unit × Actual unit
volume
 Budgeted Actual
contribution unit
Flexible Product margin/unit volume
Budget
 Grammar $70 2,880 $201,600
Translation $37
990 $ 36,630
Composition $90 630 $
56,700
 Flexible-Budget Variance
 Flexible Flexible-
Actual
budget budget Product
results amount Variance
 Grammar $216,000 $201,600 $14,400 F
Translation $39,600$ 36,630 $
2,970 F Composition $ 56,700
$56,700 0
 Total flexible-budget variance $17,370 F
(Appendix 1)
Sales-Volume Variance
 The sales-volume variance shows the
effect of the difference between the
actual and budgeted quantity of the
variable used to “flex” the flexible
budget.
 For the contribution margin of SAR
Languages Institute, this variable is
units sold.
 Sales-Volume Variance
 Sales-volume variance = (Actual sales quantity
in units – Static budget sales quantity in units)
× Budgeted contribution margin per unit
 Product
 Grammar
 Translation
 Composition
 Total sales-volume variance
 (Appendix 1)
 Sales-Mix Variance
 The sales-mix variance is the difference
between two amounts:
 Sales-mix variance = Actual units of all
products sold × (Actual sales mix
percentage – Budgeted sales mix
percentage) × Budgeted contribution
margin per unit
Sales-Mix Variance
 Grammar:

 Translation:

 Composition:

 Total sales-mix variance =

(Appendix 2)
 Sales-Quantity Variance
 The sales-quantity variance is the difference
between two amounts:

 Sales-quantity variance = (Actual units of all

products sold – Budgeted units of all products
sold) × Budgeted sales-mix percentage ×
Budgeted contribution margin per unit
 Sales-Quantity Variance
 Grammar:

Translation:

 Composition:

 Total sales-quantity variance

(Appendix 2)
 3.Market-Share Variance
 The market-share variance is the
difference between two amounts:
1 Actual market size in units (Actual market
share – Budgeted market share) ×
Budgeted contribution margin per
composite unit for budgeted mix
Market-Share Variance
 Assume that SAR Languages Institute
derives its total unit sales budget for
2017 from a management estimate of
a 20% market share and a total
industry sales forecast by Desert
Services of 24,500 units in the region.
 In 2017, Desert Services reported
actual industry sales of 28,125 units.
 Market-Share Variance
 What is SAR’s actual market share?
 4,500 ÷ 28,125 = 0.16
 Budgeted total contribution margin is
$325,360.
 Budgeted number of units is 4,900.
 What is the budgeted average contribution
margin per unit?
 $325,360 ÷ 4,900 = $66.40
 Market-Share Variance
 What is the market-share variance?

 28,125(0.16 - 0.20) × $66.40 = $74,700 U
(Appendix 3)
 Market-Size Variance
 Market-size variance = (Actual market size
in units – Budgeted market size in units) ×
Budgeted market share × Budgeted
contribution margin per composite unit for
budgeted mix
 What is the market-size variance?
 (28,125 – 24,500) × 0.20 = 725
725 × $66.40 = $48,140 F
(Appendix 3)
 Reliability of Variances
 A caution when computing market-size and
market-share variances is appropriate.
 Reliable information on market size and
market share is available for some but not
all industries.
 Obtaining reliable information on the total
market size and the relative market shares
of products is essential to the reliability of
the market-share variances.
4.Customer Revenues and Customer
Costs
 An analysis of customer differences on
both revenues and costs can provide
important insight into why differences in
customer profitability exists.
 During the first six months of 2021, SAR
Languages Institute expanded its market
and sold 200 composition programs to two
new customers in China.
 Customer A is in Beijing and customer B is
in Shanghai.
Customer Revenue Analysis
 Customer
A
B Programs sold 140
60 List selling price
$185 $185
 Invoice price $175 $180
Total revenues $24,500 $10,800
 What explanation(s) can be given for
these revenue differences?
Customer Revenue Analysis
 Two variables explain revenue
differences between these two
customers:
1 The volume of programs purchased
2 The magnitude of price discounting

 Price discounting is the reduction of

selling prices below listed levels in
order to encourage increases in
customer purchases.
Customer Cost Analysis
 Assume that SAR Languages Institute
has an activity-based costing system
that focuses on customers rather than
products.
 Activity Area Cost Driver and Rate
 Order taking $ 80 per
purchase order Set-up $100
per batch
Customer Cost Analysis
 Customer
A B

 Number of:
 Purchase orders 7 2
Batches 7 2
 What is the cost of servicing each
customer?
 Customer Cost Analysis
 Customer A:
 Ordering: 7 × $80/order = $ 560

 Set-up : 7 × $100/batch = 700

Total $1,260
 SAR can use this information to persuade this
customer to reduce usage of the ordering and set-
up cost drivers.
Customer B:
Ordering: 2 × $80/order = $160
Set-up: 2 × $100/batch = 200
 Customer-Profitability Profiles
 Customer profitability reports often
highlight that a small percentage of
customers contribute a large percentage of
operating income.
 It is important that companies devote
sufficient resources to maintaining and
expanding relationships with these key
contributors to profitability.
Customer-Profitability Profiles
 Managers find customer profitability
analysis useful for several reasons:
– It highlights how vital a small set of
customers is to total profitability.
– When a customer is ranked in the
“marginal” category, managers can
focus on ways to make future business
with this customer more profitable.
Factors affecting the allocation of
resources across customers
 Likelihood of customer retention
 Potential for customer growth
 Long run customer profitability
 Increases in overall demand from
having well-known customer
 Ability to learn from customer