Seminar 1 solution

This is one of those management accounting problems to which there is no absolute solution
– it depends on your point of view. The answer to the question “What does it cost?” can be
given in many different ways – you only have to hear the politicians disagreeing about the
cost of a new road or the National Health Service!

Here are some general thoughts to guide you.

1.Is Joe losing $5.60 on every sale of peanuts? Explain.

As stated above it depends on your point of view. Joe is a businessman and he will stay in
business if he is good at making decisions. When you make decisions, it is relevant cost that
is important – those that will change as a result of the decision. Joe has got it right in his
opening comment

Selling price $1.00

Bought in cost $0.60
Gross profit per bag $0.40
Number sold per week 50 bags
Weekly gross profit $20.00

Cost of the peanut rack £250

Number of weeks to cover 12.5

Joe has said that the peanut rack is on a “dead” place on the counter and so there is no
opportunity cost (no profits that could be made by selling something else in that position)

2.Do you agree that if the volume of peanut sales is increased, operating losses will increase?
Explain.

This is more of an accounting question as the concept of operating profit is an accounting one
rather than a decision making one. In calculating operating profit, it is normal to apportion
operating fixed costs to the operating functions. In this case the accountant is making a
reasonable point that the peanut sales should carry their share of the business overhead.
(Just like if we were to calculate the cost of an accounting student, it would have to carry a
share of library costs, university administration costs and other non-teaching costs).

We are not told Joe’s total cost, but $13,130 is the amount that the efficiency expert would
allocate to the peanut operation. If the calculation is correct, then that would indeed give an
operating loss.

Weekly Gross Profit $20

Annual Gross Profit (*52) $1040

Operating Overhead $13130

Annual Loss $12090

The more that is sold, the more the loss would be as operating overheads are often applied
as a percentage, based on forecasts.

Where the efficiency expert confuses things is to say that $2500 must also be covered. This is
a proportion of the current sales income and hence is an opportunity cost. This is now
confusing decision making accounting (management accounting) with operating profit
calculations (financial accounting)
3.Do you agree with the Efficiency-Expert that, in order to make the peanut operation
profitable, the operating costs in the restaurant should be decreased and the selling price of
the peanuts should be increased? Give reasons.

Once again, the efficiency expert is confusing the two types of accounting. If we assume that
the calculation of operating profit is a financial accounting concern, then the efficiency expert
is correct, but if we assume that we are discussing a decision making situation then clearly
the peanut operation is already profitable.

Reducing costs may be a good idea – it would depend on the value that customers perceive
in a particular type of expenditure. Increasing the selling price also depends on customer
reaction.

4. Do you think that Joe can afford to get out of the peanut business? Give reasons.

This is a decision making question and not an accounting one. So yes he can if he wants to.

5. Do you think that Joe should eliminate his peanut operations? Why or why not?

If Joe is certain that the peanut operation is a good way of using the bar space then he should
stay with it. A good business person should always look for better ways of earning money.
They should also get decent financial advice – unlike in this situation!!