Question 1

The Founder and CEO of RK Teas Inc, Rik Kassian invites you into their meeting room to look over their accounting numbers and give the company some consulting advice. In the room, are the CEO, VP of Sales and VP of Operations.

You see on the wall that RK Teas mission is to provide the highest possible quality premium organic tea ingredients and ethically sources for all of their kombucha products.

The CEO tells you that RK Teas makes organic alcoholic and non alcoholic kombucha (a bottled drink mixed with fermented tea). RK Teas sells this tea product in local grocery stores, restaurants and bars.

The CEO is feeling the pressure and says that many of the premium grocery stores are often asking for lower cost so they can pass on discounts to their customers. Rik mentions that the kombucha industry has many local producers moving into the industry and they are agressively fighting for shelf space in grocery stores and bars. During COVID, the suppliers of the raw ingredients such as organic tea and organic sugar has also been warning the company that they will have to raise the cost for future shipments and they are not sure they can keep finding ingredients that are ethically sourced.

The VP of Sales says they just got a call from a new liquor store chain called "Plant People'" that wants to buy a large order of the kombucha. Plant People would like to make a special order to buy 2,000 bottles of this premium alcohol kombucha at a low price of $39 per bottles. The VP of sales thinks they can do this order of kombucha can be produced in one batch with the available capacity but wants to know your opinion.

When you talk to the VP of operations of RK's Teas he mentions that there is pressure from Plant People to ask RK Teas to use more premium organic tea ingredients from farms to even further which could make the costs even higher in the future.

The CEO says if they do a good job on this special order that they might get an even larger ongoing account with Plant People in the future. This would allow RK Teas to buy new machinery and open up a bigger production facility. The VP of operations says they are worried that the quality might go down if they keep growing unsustainably and can't find suppliers to source this premium tea. RK Teas CEO indicates they are not utilizing their production facilitaties and they are running under capacity and he also wonder if they can reduce prices if they increase their overall production and productivity?

They pass you the numbers:

Budgeted operating information for RK Teas month (this is based on 10,000 units/month, and a normal batch size of 1,000 bottles):

RK Teas Regular Sales Information

Regular selling price per bottle of Kombucha	$55.00
RK Teas Variable costs per unit (bottle of Kombucha):
RK Teas Variable manufacturing cost	$22.00
RK Teas Batch-level cost (per batch - regardless of batch size) (= $5 per bottle (given) 1,000 bottles per batch (given))	$5,000
Plant People: Special Order Details:
Plant People Order: Selling price per unit (bottle)	$39.00
Plant People Order: Number of units	2,000
Plant People Order: Number of batches (Given)	1
Plant People Batch-level costs per unit = $2.50 = $5,000 per batch / 2,000 units per batch

RK Teas CEO asks you to study and analyze this order and what effect you think it might have on RKs Tea business in the short term and whether they should also work with Plant people more in the future?

SOLVE:

1. What will be the change in RK Tea's total operating income if they accept Plant People order?

1b What would be the change in RK Tea's total operating income if RK Tea's was operating at full capacity and, if it accepted the order from Plant People? Do you think they would lose the sale of 2,000 bottles to the regular clients? (The Vp of Operations says to assume sales lost to normal clients would be produced in 2 batches of 1,000 bottles, while the special order that you see abovecan be produced in a single batch of 2,000 bottles.)

2. The executives ask you whether this order from Plant People will work with RK Tea's competitive strategy in the short, medium and long term? What are the pros and cons of accepting this order and if they don't accept it? What cost accounting strategy do you recommend they use to deal with competitive pressures from suppliers and buyers of their product?