Customer Profitability Analysis
Omega Printers Ltd handles printing jobs. Joe Patterson, finds that serving some clients is more demanding than serving others. The demands made by some clients take up a lot of time that the sales staff would prefer to spend on soliciting new clients. In particular, Joe is interested in knowing the profitability of serving Expert Travels - a travel operator and Evon Cosmetics - a retailer. The management accounting department staff of Omega printers have provided the following information.
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Expert Travels
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Evon Cosmetics
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Sales revenue
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$554,000
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$446,800
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Cost of goods sold
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$288,000
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$223,200
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Selling costs
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$86,400
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$64,800
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Administration costs
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$68,400
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$57,600
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Cost driver data used by Omega Printers and traceable to the two clients are:
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Customer-driven activities
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Cost driver
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Cost driver rate
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Sales activity
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Sales visits
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$200 per visit
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Order taking
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Purchase orders
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$ 40 per purchase order
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Sorting & packaging
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Number of packages
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$ 50 per package
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Ordinary shipping
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Number of shipments
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$ 150 per shipment
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Special shipping
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Number of shipments
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$ 750 per shipment
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The following data relates to those same two clients:
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Customer-driven activities
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Expert Travels
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Evon Cosmetics
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Sales activity
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10 sales visits
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20 sales visits
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Order taking
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15 purchase orders
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36 purchase orders
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Sorting & Packaging
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200 packages
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1,500 packages
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Ordinary shipping
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12 shipments
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10 shipments
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Special shipping
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3 shipments
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26 shipments
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Required:
1. Prepare a customer profitability analysis for Expert Travels and Evon Cosmetics.
2. Comment on the relative profitability of the two customers by computing the gross margin, net profit margin and any other relevant ratios.
3. Suggest and explain one non-financial performance measure that Omega Printers Ltd could use to evaluate each of the following:
a. Customer acquisition
b. Customer retention
c. Customer satisfaction
Standard Costing and Variance Analysis
Chemical Manufacturing Ltd makes a cleaning product known as SuperClean by mixing three materials: A, B, and C. The standard material mix and cost to produce 9 litres of SuperClean is as follows:
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5 litres of material A at $17.00 per litre
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$85.00
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3 litres of material B at $15.00 per litre
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$45.00
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2 litres of material C at $12.00 per litre
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$24.00
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$154.00
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A standard loss of 10% of input is expected to occur.
Actual inputs used and costs incurred were as follows:
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53,000 litres of material A at $16.90 per litre
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$895,700
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28,000 litres of material B at $15.30 per litre
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$428,400
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19,000 litres of material C at $12.20 per litre
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$ 231,800
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100,000 litres
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$1,555,900
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The actual output for the period was 92,700 litres of SuperClean.
Required:
1. Calculate the price and mix variance for each material used.
2. Calculate the total material yield and total material usage variance.
3. Comment on your calculations to help explain what has happened to the material yield variance.
Transfer Pricing
Industrial Resources Company has two divisions that are involved in the internal transfer of products. The Mining Division refines a material called TZT, which is then transferred to the Metals Division. The TZT is processed into an alloy by the Metals Division, and the alloy is sold to customers at $150 per unit. The Mining Division is currently required by Industrial Resources Company to transfer its total yearly output of 400,000 units of TZT to the Metals Division at total actual manufacturing cost plus 10%. Unlimited quantities of TZT can be purchased and sold on the open market at $90 per unit. The Mining Division would incur a variable selling cost of $5 per unit if it sells on the open market. Brian Jones, manager of the Mining Division, is unhappy with having to transfer the entire output of TZT to the Metals Division at 110% of cost. In a meeting with management, he commented: "Why should my division be required to sell to the Metals Division at less than market price? My division is subsidising the profitability of the Metals Division. We should be allowed to charge the market price".
The following table shows the detailed unit cost structure for both the Mining and Metals Divisions during the most recent year:
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Mining Division
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Metals Division
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Transfer price from Mining Division
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-
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$66
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Direct material
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$12
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6
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Direct labour
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16
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20
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Manufacturing overhead
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32
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25
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Total cost per unit
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$60
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$117
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Manufacturing overhead cost in the Mining Division is 25 per cent fixed and 75 per cent variable. Manufacturing overhead cost in the Metals Division is 60 per cent fixed and 40 per cent variable.
Required:
1. Explain why the transfer prices based on actual costs are not appropriate as the basis for divisional performance measurement.
3. Using the market price as the transfer price, determine the contribution margin for both the Mining Division and the Metals Division.
4. If Industrial Resources Company were to introduce the use of negotiated transfer prices and allow divisions to buy and sell on the open market, determine the price range for TZT that would be acceptable to both the Mining Division and the Metals Division. Explain your answer.
5. Identify which one of the three types of transfer prices (cost-based, market-based or negotiated) is most likely to elicit desirable management behaviour at the Company. Explain your answer.
Decentralisation and Segment Reporting
Sparky Electrical Services is organised into three divisions: Metro, Suburban and Regional. The company uses a responsibility accounting system to evaluate the performance of its divisions and divisional managers. Data for the divisions for the last year were as follows:
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Metro
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Suburban
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Regional
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Service revenue
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$950,000
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$750,000
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$350,000
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Variable expenses
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150,000
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100,000
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50,000
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Fixed expenses controllable by divisional manager
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350,000
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270,000
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100,000
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Fixed expenses traceable to division but controllable by others
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180,000
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150,000
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40,000
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In addition to the expenses listed above, the company had $450,000 of common fixed expenses which it allocated to each division based on their percentage of total service revenue earned.
Required
Prepare a segmented income statement for Sparky Electrical Services that highlights
the profitability/performance of the three divisions and the divisional managers.
Measuring Performance
NZ Lawn Care Ltd sells a range of garden tools and fertilisers. Due to the differences in the market segments that they cater for, both garden tools and the fertilizer division operate independently, where divisional managers are responsible for investment and operating decisions of their own divisions. The performances of managers are evaluated against the target return on investment (ROI) of the company which is set at 10% and by the residual income (RI) each division generates. Managers who exceed this target are rewarded with a bonus.
The following financial information relates to the divisional performance for the year ended April 2012.
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Garden tools($)
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Fertiliser($)
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Operating profit
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1,356,000
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1,840,500
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Sales revenue
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8,475,000
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10,225,000
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Invested capital
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16,950,000
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20,450,000
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During the last financial year, both divisions were severely affected by the global economic downturn and the managers have suggested the following strategies to overcome the problem:
- The manager of the Garden tools division proposes to cut the work force by 10% by which the division's operating expenditure can be reduced by 30% without sacrificing sales revenue. In addition, he also hopes to implement a Just-in-time (JIT) system for inventories which would reduce the capital invested in the division by $2,500,000.
- The manager of the Fertiliser division reckons that the main problem with his division is the lack of sales volume due to the stiff competition that it faces. He proposed to acquire a competitor, paying $10,000,000 to consolidate the market and to increase sales. The following are the financial data pertaining to the competitor:
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Competitor ($)
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Operating profit
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980,000
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Sales revenue
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8,000,000
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In addition, both managers expressed their dissatisfaction over the company's preference to evaluate their performance based on ROI and RI. They argue that an approach based on economic value added (EVA®) would provide a better measure.
Required:
1. Compute the ROI for both divisions showing the return on sales and investment turnover for the year ended April 2012.
2. Evaluate the impact that the proposed strategies would have on ROI and RI for each division assuming that NZ Lawn Care Ltd's minimum required rate of return is 9%. (In each instance show the return on sales and investment turnover). Comment also on the validity of adopting the strategies in the short and long term.
3. Explain why EVA® is considered a superior performance evaluation method in comparison to ROI and RI?