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Costing Analysis for a Restaurant: A Tale of Contribution Margin & Overhead Allocation

Dive into the logic behind cost allocation in a restaurant scenario, emphasizing the importance of contribution margin and careful analysis of overhead expenses to make informed decisions. Explore the nuances of fully allocated costs, opportunity costs, and operating costs through a comprehensive case study.

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Costing Analysis for a Restaurant: A Tale of Contribution Margin & Overhead Allocation

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  1. Joe and thePeanut Rack “Toto, something tells me we’re not in Kansas anymore.”

  2. #2. Analyze the consultant’s logic when he goes from the “fully allocated” cost of $13,130 per year to $15,630 per year by adding the $2,500. What type of cost is the $2,500? • $150,000 ÷ 60 = $2,500 • This is an opportunity cost (revenues from the “next best alternative”) • But the space at the end of the counter is “just a dead spot.” • Even if $2,500 were the opportunity cost, it doesn’t represent “general operating costs”

  3. #3. Prepare a Contribution Margin income statement for the peanuts operation, without allocating any general overhead. Sales $1 x 50 x 52 $2,600 Variable Costs $0.60 x 50 x 52 $1,560 Contribution Margin $1,040 Fixed Costs $ 250 Net Income $ 790

  4. #4. Infer total overhead for the restaurant assuming the consultant is allocating overhead based on square feet of counter space. Total O/H $ ÷ 60 sq ft = O/H rate. O/H rate x 1 sq ft = $12,780 So total O/H is $12,780 x 60 = $766,800 Alternatively, you could calculate $13,130 x 60 = $787,800.

  5. #5. Now infer total overhead for the restaurant assuming the consultant is allocating overhead based on revenue Total revenue is calculated as follows: $150,000 + $2,600 = $152,600 Total overhead ÷ $152,600 = O/H rate. O/H rate x $2,600 peanut revenue = $12,780 So O/H rate is $12,780 ÷ $2,600 = $4.92 per revenue dollar $4.92 x 152,600 = $750,792

  6. #6. Prepare a contribution margin income statement for the restaurant, without the peanut operation, assuming the contribution margin per-centage is the same for the rest of the business as for the peanuts. Assume all overhead is fixed, and use your estimate of overhead costs from either #4 or #5 above. Sales $150,000 Variable Costs $150,000 x 60% $ 90,000 Contribution Margin $ 60,000 Fixed Costs (from 4) $787,800 Net Income (loss)($727,800)

  7. #1.In one sentence, what is the moral of the story? On one level, the moral of the story is that full costing is necessary for sound decision-making. But this assumes you believe the consultant. On another level, the moral of the story is that contribution margin analysis is the right way to approach this problem, and full costing is silly in this setting. But this assumes you believe the author of the problem.

  8. #1.In one sentence, what is the moral of the story? After the analysis you conducted in questions #2 through #6, I would like you to view the moral of the story as the following: 1. If you don’t carefully analyze the numbers, it is difficult or impossible for you to fully understand the issues. 2. Approach everything you read with a critical eye.

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