Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

duction This case is an oldie but a goodie; and it has appeared in many books and journals over the years. The authorship of this

duction This case is an oldie but a goodie; and it has appeared in many books and journals over the years. The authorship of this case seems to have been lost and that is really unfortunate. Who ever invented this case deserves the unending gratitude of at least two generations of cost accounting lecturers. I have taken the liberty of expressing everything in Pounds even though the case is probably American: I have done this purely because this is a British based site. This case concerns the restaurater who has the good idea of putting a rack of peanuts at one end of his counter. The idea being that customers would make impulse purchases of these peanuts when they are standing at the counter paying their bill, ordering a drink ... at least, he thought it was a good idea! In discussing the costs incident to various types of operations the analogy was drawn of the restaurant that adds a rack of peanuts to the counter, intending to pick up a little additional profit in the usual course of business. This analogy was attacked as an oversimplification. However, the accuracy of the analogy is evident when one considers the actual problem faced by the Restaurateur (Joe) as revealed by this Accountant-Efficiency expert. EFF EX: Joe, you said you put in these peanuts because some people ask for them, but do you realise what this rack of peanuts is costing you? JOE: It ain't gonna cost. 'sgonna be a profit. Sure, I 25 for a fancy rack to hold bags, but the peanuts cost 6p a bag and I sell 'em for 10p. Figger I sell 50 bags a week to start. It'll take weeks to cover the cost of the rack. After that I gotta clear profit of 4p a bag. The more I sell, the more I make. EFF EX: That is an antiquated and completely unrealistic approach, Joe. Fortunately, modern accounting procedures permit a more accurate picture which reveals the complexities involved. JOE: Huh? EFF EX: To be precise, those peanuts must be integrated into your entire operation and be allocated their appropriate share of business overhead. They must share a proportionate part of your expenditure for rent heat, light, equipment deprecation, decorating, salaries for your waitresses, cook...... JOE: The cook? What's he gotta do wit'a peanuts? He don't even know I got 'em. EFF EX: Look Joe the cook is in the kitchen, the kitchen prepares the food, the food is what brings people in here, and the people ask to buy peanuts. That's why you must charge a portion of the cook's wages, as well as part of your own salary to peanut sales. This sheet contains a carefully calculated cost analysis which indicates the peanut operation should pay exactly 1,278 per year toward these general overhead costs. JOE: The peanuts? 1,278 a year for overhead? The nuts? EFF EX: It's really a little more than that. You also spend money each week to have the windows washed, to have the windows washed, to have the place swept out in the mornings, keep soap in the washroom, and provide free cokes to the police. That raises the total to 1,313 per year. JOE: [Thoughtfully] But the peanut salesman said I'd make money ..... put 'em on the end of the counter, he said ... and get 4p a bag profit. EFF EX: [With a sniff] He's not an accountant. Do you actually know what the portion of the counter occupied by the peanut rack is worth to you? JOE: Ain't worth nothing - no stool there ... Just a dead spot at the end. EFF EX: The modern cost picture permits no dead spots. Your counter contains 60 square feet and your counter business grosses 15,000 a year. Consequently, the cost of a square foot of space occupied by the peanut rack is 250 per year. Since you have taken that area away the general counter use, you must charge the value of the space to the occupant. JOE: You mean I gotta add 250 a year more to the peanut? EFF EX: Right. That raises their share of the general operating costs to a grand total of 1,563 per year. Now then, if you sell 50 bags of peanuts per week, these allocated costs will amount to 60p per bag. JOE: What? EFF EX: Obviously, to that must be added your purchase price of 6p per bag, which brings the total to 66p. So you see by selling peanuts at 10p per bag, you are losing 5p on every sale. JOE: Somethin's crazy! EFF EX: Not at all! Here are the figures. They prove your peanuts operation cannot stand on its own feet. JOE: [Brightening] Suppose I sell lotsa peanuts ... thousands bags a week 'stead of fifty. EFF EX: [Tolerantly] Joe, you don't understand the problem. If the volume of peanuts sales increases, our operating costs will go up... you'll have to handle more bags with more time, more depreciation, more everything. The basic principal of accounting is firm on that subject: "The Bigger the Operation, the More General Overhead Costs That Must be Allocated." No,increasing the volume of sales won't help. JOE Okay, you so smart, you tell me what I gotta do. EFF EX: [Condescendingly] Well .... you could first reduce operating expenses. JOE: How? EFF EX: Move to a building with cheaper rent. Cut salaries. Wash the windows bi weekly. have the floor swept only on Thursday. Remove the soap from the washrooms. Decrease the square-foot value of your counter. For example, if you can cut your expenses 50%, that will reduce the amount allocated to peanut form 1,563 to 781.50 per year, reducing the cost to 36p per bag. JOE: [Slowly] That's better? EFF EX: Much, much better. However,even then you would lose 26p per bag if you only charge 10p. Therefore, you must raise your selling price. If you want a net profit of 4p per bag you would have a charge 40p. JOE: [Flabbergasted] You mean even after I cut operating costs 50% I still gotta charge 40p for a 10p of peanuts? Nobody's that nuts about nuts! who'd buy 'em? EFF EX: That's a secondary consideration. The point is, at 40p you'd be selling at a price based upon a true and fair evaluation of your then reduced costs. JOE: [Eagerly] Look! I gotta better idea. Why don't I just throw the nuts out ... put 'em in the dustbin. EFF EX: Can you afford it? JOE: Sure. All I got is about 50 bags of peanuts ... cost about three bucks.... so I lose 25 on the rack, but I get outta this nutty business and no so more grief. EFF EX: [Shaking head] Joe it isn't that simple. You are in peanut business! The minute you throw those peanuts out you are adding 1,563 of annual overhead to the rest of your operation. Joe ... be realistic... can you afford to do that? JOE: [Completely crushed] It's unbelievable! last week I was making money. Now I'm in trouble ... just because I believe 50 bags of peanuts a week is easy. EFF EX: [With raised eyebrow] that is the object of modern cost studies, Joe ... to dispel those false illusions. REQUIRED Is Joe losing 56p on every sale of peanuts? Explain. Do you agree that if the volume of peanut sales is increased, operating losses will increase? Explain. Do you agree with "Efficiency Expert" that, in order to make peanut operation profitable, the operating costs in the restaurant should be decreased and selling price of the peanuts should be increased? Give reasons. Do you think that Joe can afford to get out of the peanut business? Give reasons. Do you think that Joe should eliminate his peanut operations? Why or why not? I am willing to pay extra bonus to get this

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access with AI-Powered Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Global Strategy

Authors: Mike W. Peng

5th Edition

0357512367, 978-0357512364

Students also viewed these Accounting questions