Lecture Managerial Accounting for the hospitality industry: Chapter 9 - Dopson, Hayes

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 9

Managerial Accounting

for Costs

 The Concept of Cost

Chapter Outline

Learning Outcomes

costs

analysis

The Concept of Cost

perhaps the easiest way to understand them is to

consider their impact on a businesses’ profit

costs, the greater are its profits

managers and managerial accountants can view costs

and thus can better understand and operate their own

businesses

Types of Costs

Types of Costs

subjective matter such as “talking with customers

regarding invoices”

hospitality employee’s time to different activities

performed inside a company

on each activity by summing up the percentage of each worker's time and pay that is spent on that activity

Types of Costs

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

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

Fixed and Variable Costs

same each month

increases or decreases in sales volume (number of

guest or number of rooms)

insurance policies, property taxes, and management

salaries

Fixed and Variable Costs

increases and decreases as sales volume decreases

their lowest practical levels while still satisfying the

needs of the business and its customers

increases in variable costs are usually very good!

extra steaks and incur extra variable costs because that would mean you sold more steaks and increased sales!

Total Variable Cost Number of Guests = VC/Guest

or

$100

50 = $2.00

Mixed Costs

some vary with sales volume (variable costs)

and variable characteristics

semi-variable, or mixed costs

is an excellent example of a mixed cost

Mixed Costs

repayment, or lease, of the actual phone system

amount whether the occupancy percentage in the hotel

is very low or very high

increased telephone usage by guests

additional hotel guests result in additional telephone

calls made

g o fig ure!       

The best way to understand a mixed cost is to understand the mixed cost formula To

illustrate, assume a hotel pays $4,000 per month to lease its telephone system Assume

also that you know (from historical records) that the average guest staying at the hotel

makes one local and one long-distance telephone call The cost, to the hotel, of each

call averages $0.50 in access fees, or a total of $1.00 per guest Assume also that, in a

specific month, the hotel anticipates 7,500 guests Using the following formula for mixed

costs, the hotel’s telephone bill for the month could be estimated as:

Fixed Cost + Variable Cost = Total Mixed Cost

or Fixed Cost + (Variable Cost per Guest x Number of Guests) = Total Mixed Cost

or

$4,000 + ($1.00 x 7,500) = $11,500

Separating Mixed Costs into

Variable and Fixed Components

components in order for management to effectively

control the variable cost portion

short-term

their fixed and variable components

diagrams, and regression analysis

Separating Mixed Costs into

Variable and Fixed Components

provide more precise results, the high/low method is

easier to calculate and gives you a good estimate of the variable and fixed components of a mixed cost

components for his restaurant, see Go Figure! following

Figure 9.4

fixed costs separated for his restaurant

Figure 9.4 Joshua’s Restaurant Costs for October, November, and December

October November December

g o fig ure!       

To demonstrate how the high/low method separates a mixed cost into its variable and

fixed components, we will use Joshua’s marketing expense from Figure 9.4 The

high/low method uses the three following steps:

1 Determine variable cost per guest for the mixed cost

Choose a high volume month (December) and a low volume month (October) that

represents normal operations Then, use the following formula to separate out

variable cost per guest for the mixed cost:

High Cost – Low Cost High # of Guests – Low # of Guests = Variable Cost per Guest (VC/Guest)

or

$3,462 - $2,912 21,000 – 10,000 = $0.05

2 Determine total variable costs for the mixed cost

Multiply variable cost per guest by either the high or low volume (number of guests)

as follows:

VC/Guest x Number of Guests = Total Variable Cost

or

$0.05 x 10,000 = $500

( g o fig ure! continued)       

3 Determine the fixed costs portion of the mixed cost

Subtract total variable cost from the mixed cost (at the high volume or low volume you chose in step 2 – low volume at 10,000 guests was chosen in this example) to determine the fixed cost portion as follows

Mixed Cost – Total Variable Cost = Fixed Cost

or

At 10,000 guests served:

$2,412 + ($0.05 x 10,000) = $2,912

Figure 9.5 Joshua’s Restaurant Variable Costs per Guest and Fixed Costs

October November December

Variable Cost per Guest

Fixed Costs NUMBER OF GUESTS 10,000 17,000 21,000

Total Costs

variable costs per guest are the same for all levels of

number of guests served

such

shown in Figure 9.6

application of the Total Cost Equation

Figure 9.6 Total Cost Graph

g o fig ure!       

As you may remember from high school algebra, the equation for a line is y = a + bx

The equation for a line applies to the Total Cost line, where “a” is the y intercept (fixed costs), “b” is the slope of the line (VC/Guest), “x” is the independent variable (Number of

Guests or Sales Volume), and “y” is the dependent variable (Total Cost) The total cost

equation can be summarized as follows for Joshua’s Restaurant:

Total Cost Equation

y = a + bx

or Total Costs = Fixed Costs + (Variable Cost per Guest x Number of Guests)

or

At any number of guests served at Joshua’s Restaurant:

Total Costs = $60,000 + ($5.00 x Number of Guests)

Thus, assuming that in a normal month variable costs per guest and fixed costs remain

the same for Joshua’s restaurant, total costs in any month can be estimated by using the Total Cost Equation All Joshua must do is insert the anticipated number of guests into the equation to estimate total costs for any month For example, if Joshua expects the month of June to have 18,000 guests, he can estimate his total costs as follows:

Total Costs = Fixed Costs + (Variable Cost per Guest x Number of Guests)

or

At 18,000 guests served:

$150,000 = $60,000 + ($5.00 x 18,000)

Total Costs

the same for all levels of number of guests served

levels of guests based on the total cost equation

fixed, variable, or mixed costs in terms of being either

"good" or "bad"

volume Others are not

increase total variable costs in direct relation to

increases in total sales volume

Step Costs

increases or as a capacity limit is reached

variable costs, step cost increases look more like a

staircase (hence the name “step” costs)

provide service for a range of 1 to 30 of a restaurant’s

guests, and 40 guests are anticipated, a second server must be scheduled

costs in a non-liner (step-like) fashion

Figure 9.7 Step Costs

Direct and Indirect (Overhead)

Costs

or profit center within a business, it is known as a direct cost

increases in sales volume

specific operating unit or department

known as undistributed expenses and non-operating

expenses

Direct and Indirect (Overhead)

Costs

such as rent and other facility occupation costs,

property taxes, insurance, depreciation, amortization,

interest, and income taxes

Direct and Indirect (Overhead)

Costs

typically will use a cost allocation system to assign

portions of the overhead costs among the various

centers

on the basis of the size of each profit center

achieved by the profit center

resulting charges to the individual profit centers are also different

Figure 9.8 Harley Hotels Operations Administration

Director of Operations $ 125,000 $ 75,000 $ 200,000 Corporate Sales Director $ 90,000 $ 60,000 $ 150,000

The five hotels operated by the Harley company, their location, their number of rooms, and their annual revenues are found in Figure 9.9

Figure 9.9 Harley Hotels Managed Properties

Bitmore Denver 300 $ 15,250,000 Los Cobo Santa Fe 200 $ 8,500,000 The Drake Dallas 225 $ 11,750,000 Greenwood Miami 250 $ 10,500,000 Sandstone Las Vegas 525 $ 22,000,000

g o fig ure!       

Assume that you are the individual responsible for making cost allocation

decisions for the Harley Hotel company How would you assign the costs related

to your company employing the director of operations and the corporate sales

director?

Certainly, one approach would be to assign each hotel an equal amount of this

corporate overhead If such an approach were used, the allocation to each hotel

would be computed as:

Total Overhead Number of Profit Centers = Overhead Allocation per Profit Center

or

$ 350,000

5 = $70,000 per hotel

Figure 9.10 Overhead Allocation Based on Number of Rooms

Figure 9.11 Overhead Allocation Based on Annual Revenues

Bitmore $ 15,250,000 22.4 $ 78,400 Los Cobo $ 8,500,000 12.5 43,750 The Drake $ 11,750,000 17.3 60,550 Greenwood $ 10,500,000 15.4 53,900 Sandstone $ 22,000,000 32.4 113,400

Controllable and Non-Controllable Costs

has primary control, and non-controllable costs are those costs which a manager cannot control in the short-term

responsible for the profits remaining after subtracting the expenses they can directly control

expenses and examples of non-controllable costs are

nonoperating expenses

controllable rather than non-controllable costs

Joint Costs

the concept of a joint cost

more) departments or profit centers

costs are considered joint costs

responsible for the food production for several

departments in a hotel Each department might share

the Chef’s salary as a joint cost

Incremental Costs

increased cost of “each additional unit”, or even more

simply, the cost of “one more”

sleeping room to a single traveler

of providing this single sleeping room to a single

traveler was $40.00

“How much more does it cost to sell the same sleeping room if it is occupied by two guests, rather than one?”

Standard Costs

costs should be

is to incur costs appropriate for the quality of products

and services delivered to guests

incurred given a specific level of volume

business expenses

should be of concern to management

Sunk Costs

whose amount cannot now be altered

a sunk cost must actually be disregarded when

considering a future decision

when making decisions about the replacement or

acquisition of assets

Opportunity Costs

best alternative when making a decision

both having potential benefits or returns for you

from choosing B (opportunity cost)

organizations must choose between several similar, but not completely equal, courses of action

Cost/Volume/Profit Analysis

most hospitality businesses, some accounting periods

are simply more profitable than others

periods and “slow” periods

of sales are reduced when sales are high, and increase when sales volume is lower

volume periods and lesser profits in lower volume

periods

Cost/Volume/Profit Analysis

shown graphically in Figure 9.12, where the x

(horizontal) axis represents sales volume

served; in a hotel, it is the number of rooms sold

associated with generating the sales

guests are served or no rooms are sold, no revenue

dollars are generated

fixed costs are incurred even if no covers are sold

Figure 9.12 Cost/Volume/Profit Relationship

Cost/Volume/Profit Analysis

breakeven point

exactly equal to sales revenue

equals the sum of its total fixed and variable costs, its

breakeven point has been reached

revenues, so losses occur

of the fixed and variable costs required to make the

sales, so profits are generated

Computation of Cost/Volume/Profit Analysis

answering the question, “How much sales volume must

I generate before I begin to make a profit?”

answer another question, “How much sales dollars and volume must I generate to make my target profit level?”

dollars and volume required to achieve a breakeven

point or desired profit based on known costs

Computation of Cost/Volume/Profit Analysis

margin income statement must be developed

items in terms of sales, variable costs, contribution

margin, fixed costs, and profit

statement, see Figure 9.13

defined as the dollar amount, after subtracting variable costs from total sales, that contributes to covering fixed costs and providing for a profit (see Go Figure!)

Figure 9.13 Joshua’s Contribution Margin Income Statement for October

Total Sales $125,000 Sales Per Guest $12.50 Variable Costs 50,000 Guests Served 10,000 Contribution Margin 75,000

Fixed Costs 60,000 Before Tax Profit 15,000 Taxes (40 %) 6,000 After-tax Profit $9,000

Computation of Cost/Volume/Profit Analysis

viewed in terms of per guest and percentage sales,

variable costs, and contribution margin as shown in

Figure 9.14

guest and percent calculations

and contribution margin (CM)

calculations

Figure 9.14 Joshua’s Contribution Margin Income Statement With Per Guest and Percent Calculations

Per Guest Percent

g o fig ure!       

To calculate these numbers, the following steps apply:

Step 1 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 2 Divide VC/guest by SP/guest, and CM/guest by SP/guest to get

percentage values Then, calculate CM%

g o fig ure!       

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 %

( g o fig ure! continued)       

Joshua knows that his after-tax-profit goal is $12,000, but the preceding formula calls for

before-tax profit To convert his after-before-tax profit to before-before-tax profit, Joshua must compute the following:

After-Tax Profit = Before-Tax Profit

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 = Number of Guests to Achieve Desired After-Tax Profit Contribution Margin per Guest

or

$60,000 + $20,000 = 10,666.67 Guests, Round up to 10,667 Guests

$7.50