MANUEL S.

ENVERGA UNIVERSITY FOUNDATION

COLLEGE OF BUSINESS ADMINISTRATION

PROFITABILITY ANALYSIS OF
PHOENIX MARKETING CORPORATION
THROUGH

PROPER OVERHEAD ALLOCATION

A CASE STUDY
by

MARA ANGELI EXCIJA CADIZ

ANGEL ESPELITA CALEJA
BS Accountancy II
Submitted in partial fulfillment of the requirements
for Cost Accounting and Cost Management I

S TAT E M E N T O F T H E
PROBLEM

According to Don Hofstrand, an academician from Iowa State University,

profitability is the primary goal of all business ventures. Without profitability the
business will not survive in the long run. So measuring current and past
profitability and projecting future profitability is very important.
Our study features the case of Phoenix Marketing Corporation (PMC). PMC
operates as the distributor of a well-known brand of beer in a franchise area
covering the southern towns of the provinces of Surigao del Sur and Davao Oriental.
By years of profitability, it acquired rights to distribute soft drinks.

The

contract for the soft drinks only became effective in July 2001 but it will be
subsequently renegotiated at the beginning of 2002. At the end of year 2001, Carlito
Buenafe, PMC owner, was trying to assess the profitability of the continuity of the
contract for the soft drinks and had difficulty in doing so.
Mr. Buenafe also had a confliction on which allocation method/s hes to use in
order to help him in his assessment of the soft drinks contracts profitability and
continuity.

OBJECTIVES

Our

case

entitled

"PROFITABILITY

ANALYSIS

OF

PHOENIX

MARKETING CORPORATION THROUGH PROPER OVERHEAD ALLOCATION"

aims to assess the profitability of the PMC's franchise contract for soft drinks.

It seeks to meet the following objectives:

1. To appropriately allocate the warehouse costs to both beverage contracts

2. To assess the profitability of soft drinks contract

3. To decide whether or not new terms of contract for soft drinks should be
renegotiated or if PMC should entirely beg off from renewing the
contract

BACKGROUND

of

the

STUDY

Our study features the case of Phoenix Marketing Corporation (PMC). PMC
operates as the distributor of a well-known brand of beer in a franchise area
covering the southern towns of the provinces of Surigao del Sur and Davao Oriental.
Phoenix Marketing Corporation was marshaled in 1992. For the past ten
years, their operation has been very profitable. This led the company in the first
quarter of 2001 to reacquire its subsidiary that produces a leading soft drinks brand
and to be awarded the contract to distribute the soft drinks brand.
With this contract continuity comes the issues of profitability and allocation.
Profitability is of course a vital factor to whether continue the contract to distribute
soft drinks. That is why PMC is likewise in need of proper allocation method in
order to determine if the costs incurred are well-appropriated and pro-rated to both
beer and soft drinks distributions. Consequent to the identification of the pro-rated
costs incurred, we can better assess if the contract for soft drinks distribution is
profitable.

DISCUSSION

Foremost, let us define the terms that we need to know in order to

substantiate the case and how we can work on it.

Allocation and its Essence

First objective entails to appropriately allocate the warehouse costs to both
beverage contracts. Business Encyclopedia defines cost allocation as methods for
attributing cost to particular cost objects (Cost object is a term referring simply to
any item associated with a cost figure of its own).
In allocation, it is vital to identify the proper allocation base needed to
allocate the costs incurred. Dennis Alban in his Management Accounting Concepts
and Techniques stated that Cost Allocation Base is a quantitative characteristic
shared by multiple cost objects that is used to allocate overhead costs among the
cost objects. A cost allocation base can be a financial measure (such as the raw
material cost of each unit of product) or a nonfinancial measure (such as direct labor
hours incurred in the manufacture of each unit of product).
The Results and Recommendations of the case study shall present proper the
allocation base we have identified for each costs incurred.

Profitability and Profit Margin

Second objective is profitability. It is measured through income and expenses.

Income is the money generated from activities and expenses are the cost of
resources used up or consumed in generation of the business operations.
It is likewise significant to understand the concept of profit margins. You can
then develop strategies to increase your profit including ways to increase your sales
revenue, your profit on individual cost and services and decrease your costs. Proper
allocation of your costs is a prerequisite.
This study will use the concept of profit margin to assess the profitability of
the soft drinks distribution contract. The formula is as follows:
NET PROFIT MARGIN = NET PROFIT REVENUE
where Net Profit = Revenue Cost

Significance of Activity-Based Costing

William

Lanen,

Shannen

Anderson

and

Michael

Maher

in

their

Fundamentals of Cost Accounting 2e asserted that Activity-based costing is a twostage product costing method that allocates costs first to activity and then to the
products based on each products use of activities. This can not only be applied in
manufacturing firms. Any organization and/or businesses can better appreciate and
comprehend costs of goods and services it provides through this costing method.
As follows is the presentation of the cost flow diagram of the PMC:
Warehouse Lease & its securities

beer

salaries

utilities

other

Soft drinks

R E S U LT S &
RECOMM ENDATIONS

We have mentioned that we are to use allocation bases/cost drivers to

properly reclassify costs incurred.

We have used the following cost drivers for

allocation:
COSTS

COST-DRIVER

Salary of Dispatcher
Salaries of Checker
Salaries of
Warehousemen
Volume-related

Number of dispatches

It is mentioned that
workload of
dispatcher, checkers
and warehousemen
occurs every time a
dispatch is made.

Utilities

It is mentioned that
there exists a strong
relationship between
the incurrence of
utilities and number
of dispatches.

Warehouse Lease

The lease contract for

warehouse space was
based on the area of
the warehouse.

Warehouse-area
related

Warehouse Space

It is mentioned that
the same allocation
basis for warehouse
shall be used for this
cost.

Number of product
groups

It is mentioned that
the more product
groups PMC
distribute, the

Security

Product group-related

JUSTIFICATION

Salaries of
Administrative Staff

10

number of invoices
and record documents
the staff process
correspondingly
increases.

It is also very important to keep in mind that the contract only commenced on
the latter half of the year (particularly July 2001).

We need to consider this

whenever we do cost allocation.

The allocation table shows the results of the allocation of warehouse costs to
both beverage contracts.
COSTS

SOFTDRINKS

JUSTIFICATION

65%

35%

The salaries of the

dispatcher, checker and
warehousemen, as well
as the utilities, are
allocated in proportion
to the number of
dispatch made in
relation to the product.
That's why it is 65%
and 35% to beer and
soft drink respectively.

80%

20%

BEER

Salary of Dispatcher
Salaries of Checker
Salaries of
Warehousemen

Utilities

Warehouse Lease

Security

The warehouse rent

and securities are
allocated by allocating
80% to beer and 20% to
soft drink. It's because
in the first half of the
year, the beer
shoulders the whole
warehouse rent and
then in the other half,
it is 60% and 40% to
beer and soft drink
respectively. So it is
160% to beer and 40%

11

to soft drinks or 80%

and 20% when reduced
in lowest term.

Salaries of
Administrative Staff

75%

25%

The salaries of the

administrative staff is
said to increase as the
number of product
groups that PMC
distribute increase.
But it is not stated
that it is in proportion
to the number of
dispatch made for the
product. So the first
half of the year is
shouldered by the beer
while the other half is
allocated to both
equally which results
to 75% and 25% to beer
and soft drink
respectively.

After identifying the allocation bases/cost drivers and the allocation rate for
each product group: beer and soft drinks. The application of the allocation is
presented in Exhibit 1.
Also, allocation using relative proportion method based on commissions
earned is presented in Exhibit 2.
From these, we can see that both product groups gained profit in Exhibit 1
and from Exhibit 2, beer distribution profited while soft drinks distribution
amassed losses.

12

The question is which allocation method truly reflects profitability.

We

recommend that PMC should use the mode used in Exhibit 1 rather than the
relative proportion based on commissions.

This is because the latter fails to

consider the following circumstances:

Area that each product group occupy in the warehouse is neglected which is
vital in pro-rating lease expenses and security costs.
Commissions fail to reflect the workload done on each product group unlike
using the number of dispatch as a determinant.
Date of effectivity of contract is not taken in consideration.
There can be other external factors affecting commission that cannot be
quantified in the case.

Moreover, the losses at start up are still fine. Business life cycle illustrate
that losses at the beginning can be a possibility.

13

But its better if a business venture is profitable at the beginning. With this,
there could be a faster return of investment. Using the data in Exhibit 1, we could
deduce that the soft drinks distribution contract is a profitable business venture
considering that it only occurred starting on the latter part of the year.
Thus, with the figures and justifications presented, we, truly recommend that
Mr. Buenafe and the PMC Corporation should maintain the soft drinks distribution
contract.

14

PLAN

I M P L E M E N TAT I O N

Upon the renewal of the contract with the soft drinks distribution, PMC
should set a standard allocation base for the product groups. The use of the same
method that we did can be helpful to their management since they could compare
their net profits and assess the rate of their profitability growth.
Moreover, it would be better if PMC could secure separate records (subsidiary
ledger/s) for the soft drinks and beer product groups. This way, it would be easier
for them to assess a certain expenses direct relation to its revenue. Therefore, they
can easily identify which cost is to increase and decrease in relevance with its value.
With this knowledge, they can better manage their costs and budget expenses
to reach greater profits. They can also project commission revenues quota to further
increase productivity and consequently, profitability.

15

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