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Chapter 9 - Managerial accounting for costs. This chapter will teach you how to recognize the different types or categories of costs that managerial accountants consider when they analyze the total costs incurred by a hospitality business. The most important of these various types include fixed, variable, step, mixed, direct, indirect, controllable, and non-controllable costs.
Chapter Managerial Accounting for Costs © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Chapter Outline The Concept of Cost Types of Costs Cost/Volume/Profit Analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Learning Outcomes Identify the concept of a business cost Differentiate between the different types of business costs Perform (when costs are known) a cost/volume/profit analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes The Concept of Cost Given all the possible approaches to examining costs, perhaps the easiest way to understand them is to consider their impact on a businesses’ profit At any specific level of revenue, the lower a business’s costs, the greater are its profits There are a variety of useful ways in which hospitality managers and managerial accountants can view costs and thus can better understand and operate their own businesses © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Types of Costs Useful ways to classify business costs are: Fixed and variable costs Mixed costs Step costs Direct and indirect (overhead) costs Controllable and non-controllable costs Joint costs Incremental costs Standard costs Sunk costs Opportunity costs © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Types of Costs Not all business costs can be objectively measured In fact, in some cases, costs can be a somewhat subjective matter such as “talking with customers regarding invoices” Cost accountants facing such issues can assign each hospitality employee’s time to different activities performed inside a company An accountant can then determine the total cost spent on each activity by summing up the percentage of each worker's time and pay that is spent on that activity © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Types of Costs This process is called activity based costing and it seeks to assign objective costs to somewhat subjective items such as the payment for various types of labor as well as the even more subjective management tasks involved with planning, organizing, directing and controlling a hospitality business Using activity based costing to examine expenses and thus better manage a business is called activity based management and it is just one example of how fully understanding costs can help you make better decisions and operate a more successful business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Fixed and Variable Costs As a manager, some of the costs you incur will stay the same each month For that reason they are called fixed costs A fixed cost is one that remains constant despite increases or decreases in sales volume (number of guest or number of rooms) Typical examples of fixed costs include payments for insurance policies, property taxes, and management salaries © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Fixed and Variable Costs A variable cost is one that increases as sales volume increases and decreases as sales volume decreases Good managers seek to decrease their fixed costs to their lowest practical levels while still satisfying the needs of the business and its customers Those same good managers, however, know that increases in variable costs are usually very good! You would prefer, for example, to have to purchase extra steaks and incur extra variable costs because that would mean you sold more steaks and increased sales! © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To illustrate, consider Maureen’s Bountiful Burgers, a midsize, freestanding restaurant outside a shopping mall, where Maureen features upscale gourmet burgers If it costs $2.00 of ingredients to make a gourmet burger and 50 guests order burgers, then the total variable food cost is as follows: Variable Cost per Guest (VC/Guest) x Number of Guests = Total Variable Cost or $2.00 x 50 = $100 If the total variable cost and the number of guests are known, VC/Guest can be determined Using basic algebra, a variation of the total variable cost formula can be computed as follows: Total Variable Cost Number of Guests = VC/Guest or $100 50 © 2009 John Wiley & Sons Hoboken, NJ 07030 = $2.00 10 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! As you can see in Figure 9.13, the contribution margin calculation for Joshua’s is as follows: Total Sales – Variable Costs = Contribution Margin or $125,000 – $50,000 = $75,000 © 2009 John Wiley & Sons Hoboken, NJ 07030 45 Managerial Accounting for the Hospitality Industry Dopson & Hayes Computation of Cost/Volume/Profit Analysis The contribution margin income statement can also be viewed in terms of per guest and percentage sales, variable costs, and contribution margin as shown in Figure 9.14 Notice the boxed information in Figure 9.14 includes per guest and percent calculations These include selling price, (SP), variable costs (VC), and contribution margin (CM) See Go Figure! for the steps to follow in CVP calculations © 2009 John Wiley & Sons Hoboken, NJ 07030 46 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 9.14 Joshua’s Contribution Margin Income Statement With Per Guest and Percent Calculations Per Guest Total Sales $125,000 SP Variable Costs 50,000 Contribution Margin 75,000 Fixed Costs 60,000 Before-Tax Profit 15,000 Taxes (40%) 6,000 After-Tax Profit 9,000 © 2009 John Wiley & Sons Hoboken, NJ 07030 Percent $12.50 100% - VC 5.00 40 CM 7.50 60 Guests served = 10,000 47 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To calculate these numbers, the following steps apply: Step Divide total sales, variable costs, and contribution margin by the number of guests to get per guest values Then, calculate CM/guest SP/guest = $125,000/10,000 guests = $12.50 VC/guest = $ 50,000/10,000 guests = $ 5.00 CM/guest = $ 75,000/10,000 guests = $ 7.50 SP/guest – VC/guest = CM/guest or $12.50 – $5.00 = $7.50 Step Divide VC/guest by SP/guest, and CM/guest by SP/guest to get percentage values Then, calculate CM% SP% = 100% VC% = $5.00/$12.50 = 40% CM% = $7.50/$12.50 = 60% SP% – VC% = CM% or 100% – 40% = 60% © 2009 John Wiley & Sons Hoboken, NJ 07030 48 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To determine the dollar sales required to break even, Joshua uses the following formula: Fixed Costs Contribution Margin % = Breakeven Point in Sales Dollars or $60,000 = $100,000 0.60 Thus, Joshua must generate $100,000 in sales per month before he begins to make a profit At a sales volume of less than $100,000, he would be operating at a loss In terms of the number of guests that must be served in order to break even, Joshua uses the following formula: Fixed Costs Contribution Margin per Guest = Breakeven Point in Guests Served or $60,000 = 8,000 Guests $7.50 Now, assume that Joshua has decided that in July he will plan for $12,000 in after-tax profits To determine sales dollars and covers needed to achieve his after-tax profit goal, Joshua uses the following formula: Fixed Costs + Before-Tax Profit = Sales Dollars to Achieve Desired After-Tax Profit Contribution Margin % © 2009 John Wiley & Sons Hoboken, NJ 07030 49 Managerial Accounting for the Hospitality Industry Dopson & Hayes ( g o fig u re! continued) Joshua knows that his after-tax-profit goal is $12,000, but the preceding formula calls for beforetax profit To convert his after-tax profit to before-tax profit, Joshua must compute the following: After-Tax Profit = Before-Tax Profit – Tax Rate or $12,000 = $20,000 – 0.40 Now that Joshua knows his before-tax profit goal is $20,000, he can calculate his sales dollars to achieve his desired after-tax profit as follows: Fixed Costs + Before-Tax Profit = Sales Dollars to Achieve Desired After-Tax Profit Contribution Margin % or $60,000 + $20,000 = $133,333.33 0.60 Thus, Joshua must generate $133,333.33 in sales in July to achieve his desired after-tax profit of $12,000 In terms of calculating the number of guests that must be served in order to make his profit, Joshua uses the following formula: Fixed Costs + Before-Tax Profit Contribution Margin per Guest = Number of Guests to Achieve Desired After-Tax Profit or $60,000 + $20,000 = 10,666.67 Guests, Round up to 10,667 Guests $7.50 © 2009 John Wiley & Sons Hoboken, NJ 07030 50 Managerial Accounting for the Hospitality Industry Dopson & Hayes Computation of Cost/Volume/Profit Analysis You must always round the number of guests up because A guest (person) does not exist as a fraction It is better to slightly overstate the number of guests to achieve breakeven or desired profits than to understate the number and risk a loss or reduce profit It is better to be safe than sorry! Once you round the number of guests up, you should adjust the total sales dollars to reflect this This difference is minimal and may not warrant adjustment unless an exact sales dollar amount is required based on number of guests © 2009 John Wiley & Sons Hoboken, NJ 07030 51 Managerial Accounting for the Hospitality Industry Dopson & Hayes Computation of Cost/Volume/Profit Analysis When calculating sales and guests (or rooms) to achieve breakeven and desired after-tax profits, you can easily remember which formulas to use if you know the following: Contribution margin % is used to calculate sales dollars Contribution margin per guest (or room) is used to calculate sales volume in guests (or rooms) © 2009 John Wiley & Sons Hoboken, NJ 07030 52 Managerial Accounting for the Hospitality Industry Dopson & Hayes Computation of Cost/Volume/Profit Analysis You can predict any sales level for breakeven or aftertax profits based on your selling price, fixed costs, variable costs, and contribution margin You can also make changes in your selling prices and costs to improve your ability to breakeven and achieve desired profit levels © 2009 John Wiley & Sons Hoboken, NJ 07030 53 Managerial Accounting for the Hospitality Industry Dopson & Hayes Margin of Safety Margin of safety shows how close a projected amount of sales will be to breakeven, and thus, how close an operation will be to incurring a loss Margin of safety calculates the difference between projected sales and breakeven sales Once the margin of safety for the month is calculated, it can be divided by the number of days in the month to show the margin of safety per day These calculations are illustrated in Figure 9.15 © 2009 John Wiley & Sons Hoboken, NJ 07030 54 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 9.15 Joshua’s Margin of Safety for August Sales $ Guests Projected Sales 112,500 9,000 Breakeven Sales - 100,000 - 8,000 Margin of Safety 12,500 1,000 Margin of Safety per Day (31 days) 403.23 32.26 ~ 32 © 2009 John Wiley & Sons Hoboken, NJ 07030 55 Managerial Accounting for the Hospitality Industry Dopson & Hayes Margin of Safety You must always round the number of guests for margin of safety down because A guest (person) does not exist as a fraction It is better to slightly understate the number of guests as a safety margin than to overstate the number and thus, your safety net It is better to be safe than sorry! Once you round the number of guests down, you should adjust the margin of safety dollars to reflect this This difference is minimal and may not warrant adjustment unless an exact sales dollar amount is required based on number of guests © 2009 John Wiley & Sons Hoboken, NJ 07030 56 Managerial Accounting for the Hospitality Industry Dopson & Hayes Minimum Sales Point A minimum sales point (MSP) is defined as the dollar sales volume required to justify staying open for a given period of time The information necessary to compute a MSP is as follows: Food cost % Minimum payroll cost for the time period Variable cost % Fixed costs are eliminated from the calculation because, even if the volume of sales equals zero, fixed costs still exist and must be paid © 2009 John Wiley & Sons Hoboken, NJ 07030 57 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! Consider the situation of Adrian, who is trying to determine whether he should close his steakhouse at 10:00 p.m or 11:00 p.m Adrian wants to compute the sales volume necessary to justify staying open the additional hour He can make this calculation because he knows that his food cost equals 40%, his minimum labor cost to stay open for the extra hour equals $150, and his other variable costs (taken from his P&L statement) equal 30% In calculating MSP, his food cost % + variable cost % is called his minimum operating cost Adrian applies the MSP formula as follows: Minimum Labor Cost – Minimum Operating Cost = MSP or Minimum Labor Cost – (Food Cost % + Variable Cost %) = MSP or $150 – (0.40 + 0.30) = $500 If Adrian can achieve a sales volume of $500 in the 10:00 p.m to 11:00 p.m time period, he should stay open If this level of sales is not feasible, he should consider closing the operation at 10:00 p.m © 2009 John Wiley & Sons Hoboken, NJ 07030 58 Managerial Accounting for the Hospitality Industry Dopson & Hayes Review of Learning Outcomes Identify the concept of a business cost Differentiate between the different types of business costs Perform (when costs are known) a cost/volume/profit analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 59 Managerial Accounting for the Hospitality Industry Dopson & Hayes ... increases the restaurants costs in a non-liner (step-like) fashion © 20 09 John Wiley & Sons Hoboken, NJ 07030 24 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 9. 7 Step... Costs Server Cost Server Server 1-3 0 3 1-6 0 61 -9 0 Volume © 20 09 John Wiley & Sons Hoboken, NJ 07030 25 Managerial Accounting for the Hospitality Industry Dopson & Hayes Direct and Indirect (Overhead)... $60,000 19 Managerial Accounting for the Hospitality Industry Dopson & Hayes Total Costs As you can see in Figure 9. 5, total fixed costs and total variable costs per guest are the same for all