Cost Classifications External reporting Predicting cost behavior Assigning costs to cost objects ...

AUSSIE PIES (A)

Cost Classifications


External reporting Predicting cost behavior Assigning costs to cost objects Decision making


External reporting Product vs. period costs

Predicting cost behavior Variable vs. fixed costs

Assigning costs to cost objects Direct vs. indirect costs

Decision making Relevant vs. irrelevant costs

LET’S DEFINE ALL OF THE COSTS MENTIONED IN THE CASE.

WHO CAN GIVE ME ONE COST MENTIONED IN THE CASE?

Aussie Pies’ Costs

Ingredients Utilities for cooking Utilities for lighting the store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Let’s start by looking at these costs from an external reporting perspective.

Cracker Barrel

The Cheesecake Factory

Cost Classification Summary

Product

Period

Variable

Fixed

Direct

Indirect

Relevant

Irrelevant

Ingredients

Utilities for cooking

Utilities for lighting in store

Pie boxes

Rent on store

Rent on cooking equipment

Rent on fixtures

Chefs salaries

Sales assistant salary

Product vs. Period Costs(external reporting)

Product Period

Ingredients



Pie boxes

Rent on store


Rent on fixtures

Chefs salaries


Product vs. Period Costs(external Reporting)

Product Period

Ingredients √

Utilities for cooking √

Utilities for lighting in store √

Pie boxes √

Rent on store √

Rent on cooking equipment √

Rent on fixtures √

Chefs salaries √

Sales assistant salary √

What are the profit implications of treating a cost such as utilities for

cooking as a period cost rather than a product cost?

Product Costs(excluding raw materials inventory)

Product Costs(excluding raw

materials)

Cost of goods sold

Ending work in process inventory or

ending finished goods inventory

Period Costs

Selling & Admin. expense

Income StatementBalance Sheet

Does a restaurant have work in process or finished goods

inventory?

A Matching Perspective

Why not include the rental cost of cooking equipment in COGS?


Why not include the rental cost of cooking equipment in COGS? A manufacturer treats manufacturing

equipment depreciation as a product cost because some units may be produced in the current period but not sold until a later period.


Why not include the rental cost of cooking equipment in COGS? A manufacturer treats manufacturing

equipment depreciation as a product cost because some units may be produced in the current period but not sold until a later period.

A software developer incurs costs to develop products that will be sold in a later period. So in these two instances there is a need to

match costs with revenues.


Why not include the rental cost of cooking equipment in COGS? A manufacturer includes equipment depreciation in

product cost because some units may be produced in the current period but not sold until a later period.

A software developer incurs costs to develop products that will be sold in a later period. So in these two instances there is a need to match

costs with revenues. There is no such matching concern with a

restaurant. Furthermore, cost of goods sold is more useful if not confounded with various non-food costs.

From an external reporting perspective, what would be Aussie Pie’s unit product cost?

Unit Product Cost

Amount

Ingredients

Pie boxes

Unit product cost

Unit Product Cost

Amount

Ingredients $1.20

Pie boxes $0.02

Unit product cost $1.22

Let’s look at Aussie Pies’ costs from a cost behavior standpoint.

Variable vs. Fixed Costs

(with respect to the number of pies produced)

Variable Fixed

Ingredients



Pie boxes

Rent on store


Rent on fixtures

Chefs salaries


Variable vs. Fixed Costs

(with respect to the number of pies produced)

Variable Fixed

Ingredients √



Pie boxes √

Rent on store √



Chefs salaries √


WHAT ARE AUSSIE PIE’S FIXED COST PER MONTH?

Fixed Costs

Amount


Rent on store


Rent on fixtures

Chefs salaries


Total fixed costs

Fixed Costs

Amount

Utilities for lighting in store $300

Rent on store 11,900

Rent on cooking equipment 8,000

Rent on fixtures 5,000

Chefs salaries 3,600

Sales assistant salary 1,200

Total fixed costs $30,000

WHAT ARE AUSSIE PIE’S VARIABLE COSTS PER PIE?

Variable Costs

Amount

Ingredients $1.20

Utilities 0.03

Packaging 0.02

Total variable cost per pie $1.25

Cost Behavior

Total VC VC/Unit Total FC FC/Unit Cost/Unit

5,000 units

10,000 units

15,000 units

20,000 units

25,000 units

30,000 units

Cost Behavior


5,000 units

$1.25

10,000 units

$1.25

15,000 units

$1.25

20,000 units

$1.25

25,000 units

$1.25

30,000 units

$1.25

Cost Behavior


5,000 units

$1.25 $30,000

10,000 units

$1.25 $30,000

15,000 units

$1.25 $30,000

20,000 units

$1.25 $30,000

25,000 units

$1.25 $30,000

30,000 units

$1.25 $30,000

Cost Behavior


5,000 units

$6,250 $1.25 $30,000

10,000 units

$12,500 $1.25 $30,000

15,000 units

$18,750 $1.25 $30,000

20,000 units

$25,000 $1.25 $30,000

25,000 units

$31,250 $1.25 $30,000

30,000 units

$37,500 $1.25 $30,000

Cost Behavior


5,000 units

$6,250 $1.25 $30,000 $6.00

10,000 units

$12,500 $1.25 $30,000 $3.00

15,000 units

$18,750 $1.25 $30,000 $2.00

20,000 units

$25,000 $1.25 $30,000 $1.50

25,000 units

$31,250 $1.25 $30,000 $1.20

30,000 units

$37,500 $1.25 $30,000 $1.00

Cost Behavior


5,000 units

$6,250 $1.25 $30,000 $6.00 $7.25

10,000 units

$12,500 $1.25 $30,000 $3.00 $4.25

15,000 units

$18,750 $1.25 $30,000 $2.00 $3.25

20,000 units

$25,000 $1.25 $30,000 $1.50 $2.75

25,000 units

$31,250 $1.25 $30,000 $1.20 $2.45

30,000 units

$37,500 $1.25 $30,000 $1.00 $2.25

Let’s look at the topic of assigning costs to cost objects.

Direct vs. Indirect Costs

If Aussie Pies eventually opened a second store and hired two additional chefs for that store, then what would be the direct and indirect costs with respect to a specific store?


Direct Indirect

Ingredients



Pie boxes

Rent on store


Rent on fixtures

Chefs salaries



Direct Indirect

Ingredients √



Pie boxes √

Rent on store √



Chefs salaries √


Let’s look at the topic of cost classifications for decision making.

Relevant vs. Irrelevant Costs Assume the Aussie Pies’ owners

claimed that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.

Relevant vs. Irrelevant Costs Assume the Aussie Pies’ owners

claimed that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.

Assume that Aussie Pies turned down a corporate client that wanted to buy 1,000 pies at $2.00 each because the price was below $2.25 per pie.

Comment on the wisdom of this decision.

Relevant vs. Irrelevant Costs Assume the Aussie Pies’ owners claimed

that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.

Assume that Aussie Pies turned down a corporate client that wanted to buy 1,000 pies at $2.00 each because the price was below $2.25 per pie.

Comment on the wisdom of this decision. Does the concept of “opportunity cost” affect

your answer?

Relevant vs. Irrelevant Costs If Aussie Pies is considering staying

open 2 additional hours everyday, what costs on the next slide would be potentially relevant to this decision?

Relevant vs. Irrelevant Costs

Relevant Irrelevant

Ingredients



Pie boxes

Rent on store


Rent on fixtures

Chefs salaries


Relevant vs. Irrelevant Costs

Relevant Irrelevant

Ingredients √



Pie boxes √

Rent on store √



Chefs salaries √


Assumes that Chefs would demand an increase in salary to work two extra hours everyday.

Cost Classification Summary

Product

Period

Variable

Fixed

Direct

Indirect

Relevant

Irrelevant

Ingredients √ √ √ √Utilities for cooking √ √ √ √Utilities for lighting in store √ √ √ √

Pie boxes √ √ √ √Rent on store √ √ √ √Rent on cooking equipment √ √ √ √

Rent on fixtures √ √ √ √Chefs salaries √ √ √ √Sales assistant salary √ √ √ √

Let’s take a closer look at the value of understanding cost behavior.

HOW MANY AUSSIE PIES HAVE TO BE SOLD TO BREAKEVEN?

Equation Method

(P)(Q) E (V)(Q) E F = Profit

Equation Method

($3.25)(Q ) E ($1.25)(Q) E $30,000 = 0

2Q = $30,000

Q = 15,000 pies

What is the breakeven point in sales dollars?

Equation Method

($3.25)(Q ) E ($1.25)(Q) E $30,000 = 0

2Q = $30,000

Q = 15,000 pies

15,000 pies × $3.25 = $48,750

HOW MANY AUSSIE PIES HAVE TO BE SOLD TO EARN A 20% RETURN ON SALES?

Equation Method

($3.25)(Q) E ($1.25)(Q) E $30,000 = ($0.65)Q

1.35Q = $30,000

Q = 22,223 pies

WHAT PROFIT WOULD AUSSIE PIES EARN IF IT RAISED INGREDIENTS COST BY $0.50, INVESTED $5,000 IN A MONTHLY ADVERTISING CAMPAIGN AND WAS ABLE TO SELL 25,000 UNITS AT $3.25 PER UNIT?

Equation Method

($3.25)(25,000) E ($1.75)(25,000) E $35,000 = Profit

Profit = $2,500

AUSSIE BELIEVES IT CAN SELL 20,000 PIES AT A PRICE OF $3.25. HOWEVER, BASED ON MARKET RESEARCH IT BELIEVES FOR EACH $0.25 SHIFT IN PRICE, DEMAND WILL SHIFT BY 1,500 PIES. WHAT IS THE OPTIMAL PRICE?

Optimal Price

Volume PriceVC perUnit

CM per Unit

TotalCM

FixedCosts Profit

20,000 units $3.25

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25

24,500 units $2.50

23,000 units $2.75

21,500 units $3.00

20,000 units $3.25

18,500 units $3.50

17,000 units $3.75

15,500 units $4.00

14,000 units $4.25

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25 $1.25

24,500 units $2.50 $1.25

23,000 units $2.75 $1.25

21,500 units $3.00 $1.25

20,000 units $3.25 $1.25

18,500 units $3.50 $1.25

17,000 units $3.75 $1.25

15,500 units $4.00 $1.25

14,000 units $4.25 $1.25

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25 $1.25 $1.00

24,500 units $2.50 $1.25 $1.25

23,000 units $2.75 $1.25 $1.50

21,500 units $3.00 $1.25 $1.75

20,000 units $3.25 $1.25 $2.00

18,500 units $3.50 $1.25 $2.25

17,000 units $3.75 $1.25 $2.50

15,500 units $4.00 $1.25 $2.75

14,000 units $4.25 $1.25 $3.00

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25 $1.25 $1.00 $26,000

24,500 units $2.50 $1.25 $1.25 $30,625

23,000 units $2.75 $1.25 $1.50 $34,500

21,500 units $3.00 $1.25 $1.75 $37,625

20,000 units $3.25 $1.25 $2.00 $40,000

18,500 units $3.50 $1.25 $2.25 $41,625

17,000 units $3.75 $1.25 $2.50 $42,500

15,500 units $4.00 $1.25 $2.75 $42,625

14,000 units $4.25 $1.25 $3.00 $42,000

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25 $1.25 $1.00 $26,000

$30,000

24,500 units $2.50 $1.25 $1.25 $30,625

$30,000

23,000 units $2.75 $1.25 $1.50 $34,500

$30,000

21,500 units $3.00 $1.25 $1.75 $37,625

$30,000

20,000 units $3.25 $1.25 $2.00 $40,000

$30,000

18,500 units $3.50 $1.25 $2.25 $41,625

$30,000

17,000 units $3.75 $1.25 $2.50 $42,500

$30,000

15,500 units $4.00 $1.25 $2.75 $42,625

$30,000

14,000 units $4.25 $1.25 $3.00 $42,000

$30,000

Optimal Price


CM per Unit

TotalCM

FixedCosts Profit

26,000 units $2.25 $1.25 $1.00 $26,000

$30,000

$(4,000)

24,500 units $2.50 $1.25 $1.25 $30,625

$30,000

$625

23,000 units $2.75 $1.25 $1.50 $34,500

$30,000

$4,500

21,500 units $3.00 $1.25 $1.75 $37,625

$30,000

$7,625

20,000 units $3.25 $1.25 $2.00 $40,000

$30,000

$10,000

18,500 units $3.50 $1.25 $2.25 $41,625

$30,000

$11,625

17,000 units $3.75 $1.25 $2.50 $42,500

$30,000

$12,500

15,500 units $4.00

$1.25

$2.75 $42,625

$30,000

$12,625

14,000 units $4.25 $1.25 $3.00 $42,000

$30,000

$12,000

Assume that Aussie Pies decides to pay its sales assistant a

commission of $0.06 per pie sold instead of a salary and each chef is paid a salary of $1,000 plus a

commission of $0.04 per pie sold. If Aussie Pies sells 22,000 units, how would it prepare an income statement for external reporting

purposes?

Traditional Income Statement

Amount

Sales

Cost of goods sold

Gross margin

Operating expenses:

Chefs compensation

Utilities expense

Rent expense

Selling expense

Total operating expenses

Net operating income

Traditional Income Statement

Amount

Sales (22,000 × $3.25) $71,500

Cost of goods sold (22,000 × $1.22) 26,840

Gross margin 44,660

Operating expenses:

Chefs compensation (($2,000 + (22,000 × $0.04 × 2))

$3,760

Utilities expense ($300 + (22,000 × $0.03))

$960

Rent expense ($11,900 + $8,000 + $5,000)

$24,900

Selling expense (22,000 × 0.06) $1,320

Total operating expenses $30,940

Net operating income $13,720

Given the same assumptions, how would Aussie Pies prepare a contribution format income

statement?

Contribution Margin Income Statement

Amount

Sales

Cost of goods sold

Chefs commission

Cooking utilities

Selling commission

Total variable cost

Contribution margin

Chefs salaries

Utilities expense

Rent expense

Total fixed cost

Net operating income

Contribution Margin Income Statement

Amount

Sales (22,000 × $3.25) $71,500

Cost of goods sold (22,000 × $1.22) 26,840

Chefs commission (22,000 × $0.04 × 2) 1,760

Cooking utilities (22,000 × $0.03) 660

Selling commission (22,000 × $0.06) 1,320

Total variable cost 30,580

Contribution margin 40,920

Chefs salaries 2,000

Utilities expense 300

Rent expense 24,900

Total fixed cost 27,200

Net operating income $13,720

Cost Classifications External reporting Predicting cost behavior Assigning costs to cost objects ...

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