Introduction to the company:

PepsiCo is a leading global beverage, snack and Food Company. They manufacture or
use contract manufacturers, market and sell a variety of salty, convenient, sweet and
grain-based snacks, carbonated and non-carbonated beverages and foods in
approximately 200 countries, with its largest operations in North America (United States
and Canada), Mexico and the United Kingdom. PepsiCo’s commitment to sustainable
growth, defined as Performance with Purpose, is focused on generating healthy financial
returns while giving back to the communities it serves. This includes meeting consumer
needs for a spectrum of convenient foods and beverages, reducing its impact on the
environment through water, energy and packaging initiatives, and supporting its
employees through a diverse and inclusive culture that recruits and retains world-class
talent.
The Pepsi Cola Company began in 1898 by a Pharmacist and Industrialist Caleb
Bradham, but it only became known as PepsiCo when it merged with Frito Lay in 1965.
Until 1997, it also owned KFC, Pizza Hut, and Taco Bell, but these fast-food restaurants
were spun off into Tricon Global Restaurants. In December 2005, PepsiCo surpassed
Coca-Cola Company in market value for the first time in 112 years since both companies
began to compete.

PepsiCo’s Operations:

PepsiCo is organized into three business units, as follows:

(1) PepsiCo Americas Foods (PAF), which includes Frito-Lay North America
(FLNA), Quaker Foods North America (QFNA) and all of Latin American food and
snack businesses (LAF).
(2) PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages
North America and the entire Latin American beverage Businesses.
(3) PepsiCo International (PI), which includes all PepsiCo businesses in the
United Kingdom, Europe, Asia, Middle East and Africa
These three business units are comprised of six reportable segments (referred to as
divisions), as follows:

- Frito-Lay North America (FLNA)

- Quaker Foods North America (QFNA)
- Latin America Foods (LAF)
- PepsiCo America Beverages (PAB)
- United Kingdom & Europe (UKEU), and
- Middle East, Africa & Asia (MEAA).
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The part of our concern in this report will be the Middle East, Africa and Asia (MEAA)
division as our research and collected data is confined to this region.

Middle East, Africa & Asia

MEAA manufactures, markets and sells through consolidated businesses as well as

through non controlled affiliates, a number of leading salty and sweet snack brands
including Lay’s, Doritos, Cheetos, Smith’s and Ruffles. Further, MEAA manufactures or
Uses contract manufacturers, markets and sells many Quaker brand cereals and snacks.
MEAA also manufactures markets and sells beverage concentrates, fountain syrups and
finished goods, under various beverage brands including Pepsi, Marinda, 7UP and
Mountain Dew. These brands are sold to authorized bottlers, independent distributors and
retailers. However, in certain markets, MEAA operates its own bottling plants and
distribution facilities. In addition, MEAA licenses the Aquafina water brand to certain of
its authorized bottlers. MEAA also manufactures or uses contract manufacturers, markets
and sells ready-to-drink tea products through an international joint venture with Unilever.

Competition:

PepsiCo operates in highly competitive markets. It competes against global, regional,

local and private label manufacturers on the basis of price, quality, product variety and
distribution. In U.S. measured channels, its chief beverage competitor, The Coca-Cola
Company, has a larger share of carbonated soft drinks (CSD) consumption, while
PepsiCo has a larger share of liquid refreshment beverages consumption. In addition, The
Coca-Cola Company has a significant CSD share advantage in many markets outside the
United States. Further, PepsiCo’s snack brands hold significant leadership positions in
the snack industry worldwide. Its snack brands face local and regional competitors, as
well as national and global snack competitors, and compete on the basis of price, quality,
product variety and distribution. Success in this competitive environment is dependent on
effective promotion of existing products and the introduction of new products. PepsiCo
believes that the strength of its brands, innovation and marketing, coupled with the
quality of its products and flexibility of its distribution network, allow it to compete
effectively.

Critical Accounting Policies:

These policies may require management to make difficult and subjective judgments
regarding uncertainties, and as a result, such estimates may significantly impact

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Company’s financial results. The precision of these estimates and the likelihood of future
changes depend on a number of underlying variables and a range of possible outcomes.
PepsiCo’s critical accounting policies arise in conjunction with the Following:
• Revenue recognition,
• Brand and goodwill valuations,
• Income tax expense and accruals

Revenue Recognition
PepsiCo’s products are sold for cash or on credit terms. The credit terms, which are
established in accordance with local and industry practices they typically require payment
within 30 to 90 days internationally, and may allow discounts for early payment. It
recognizes revenue upon shipment or delivery to its customers based on written sales
terms that do not allow for a right of return. However, its policy for DSD and chilled
products is to remove and replace damaged and out-of-date products from store shelves
to ensure that consumers receive the product quality and freshness they expect. Similarly,
its policy for certain warehouse-distributed products is to replace damaged and out-of-
date products. Based on the company’s experience with this practice, it has reserved for
anticipated damaged and out-of-date products.

Brand and Goodwill Valuations:

PepsiCo sells products under a number of brand names, many of which were developed
by PepsiCo. The brand development costs are expensed as incurred. There are other
brands that PepsiCo has acquired. Upon acquisition, the purchase price is first allocated
to identifiable assets and liabilities, including brands, based on estimated fair value, with
any remaining purchase price recorded as goodwill. Determining fair value requires
significant estimates and assumptions based on an evaluation of a number of factors, such
as
 marketplace participants
 product life cycles
 market share
 consumer awareness
 brand history and future expansion expectations
 amount and timing of future cash flows
 The discount rate applied to the cash flows.
The company believes that a brand has an indefinite life if it has a history of strong
revenue and cash flow performance, and we have the intent and ability to support the
brand with marketplace spending for the foreseeable future. If these perpetual brand

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criteria are not met, brands are amortized over their expected useful lives, which
generally range from five to 40 years.

Income Tax Expense and Accruals:

The annual tax rate is based on company’s income, statutory tax rates and tax planning
opportunities available in the various jurisdictions in which the company operates.
Significant judgment is required in determining annual tax rate and in evaluating tax
position. Deferred tax liabilities generally represent tax expense recognized in financial
statements for which payment has been deferred, or expense for which the company has
already taken a deduction in tax return but have not yet recognized as expense in the
financial statements. In 2008, the annual tax rate was 26.8% compared to 25.9% in
2007.The tax rate in 2008 increased 0.9 percentage points primarily due to the absence of
the tax benefits recognized in the prior year related to the favorable resolution of certain
foreign tax matters, partially offset by lower taxes on foreign results in the current year.
In 2009, annual tax rate is expected to be approximately the same as 2008.

Lays- Potato Chips

Lay's is the brand name for a number of potato chip (a.k.a crisps) varieties
as well as the name of the company that founded the chip brand in
1938. Lay's chips are marketed as a division of Frito-Lay, a company
owned by PepsiCo Inc. since 1965.
For the internal accounting analysis purposes we have selected the
snacks department of PepsiCo. In this department we further narrow
it down to “Lays”
In Pakistan, Lays is available in mainly 5 flavors and is now the most
popular snack amongst youngsters of the country.
- French Cheese
- Salted
- Masala
- Tango
- Bar B.Q

Factory Tour:

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Our group paid a visit to the office of PepsiCo located in Gulberg, Lahore. We needed to
have a one-on-one conversation with the staff to get an idea of how PepsiCo handles its
internal finances. Since this kind of information was not available officially, we decided
to get it first hand.
Since we had set a meeting beforehand, we did not face any difficulty in getting in. The
staff, on a general level, was very friendly and helpful. Although, they did make us wait
for about half an hour before beginning the interview.
We were escorted to a room upstairs which was finely decorated, just like the entrance
lounge. The Factory Finance Manager from the snacks department introduced himself
and the question answer session begun.
He briefed us about the cost of goods sold which included direct material, direct labor
and manufacturing overhead costs. He then elaborated each category with the specific
example of potato chips. The raw material includes potatoes, oil and flavor.

The direct labor comprised of three steps

1. Raw Material
2. Processing
3. Packaging
Lastly, he explained the manufacturing overhead with the example of electricity. Other
than this, he told us about the marketing costs that were incurred by the company. Its
record is kept separately.
In the beginning, they were quite reluctant about giving out the information. However,
they cooperated with us on the maximum level which they thought was appropriate.

Internal Accounting Procedures:

The snacks department of Pepsi Co. has the following major divisions where costs are
accumulated.
- Production
- Finance
- R&D
- Planning
- Personnel
- Marketing
o SAD(sales and distribution)
o ANM (advertising and marketing)
o GNA (General and administrative)
The costing is mainly associated to the production department. The rest of this report
includes a detailed analysis of the costing procedures carried out in PepsiCo’s snack’s
production department.
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 Costs Classification:

Cost Classification

Manufacturing Costs Non- Manufacturing

Costs

Direct Direct Manufacturing Selling Administrative

Material Labor Overhead Costs Costs

Variable Fixed
Manufacturing Manufacturing
Overhead Overhead

Manufacturing Costs:

Manufacturing cost is the expenditure incurred in carrying out the production processes
of an organization. The manufacturing cost includes direct costs, for example, labor,
materials, and expenses, and indirect costs, for example, subcontracting and overheads.
The costs identified as manufacturing costs in the production of Lays are as follows;

1. Direct Materials

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The materials that go into final product are called raw materials
- Potato
- Oil
- Seasoning(flavour)
- Film (packet)
- Carton

2. Direct Labour
The term direct labor is reserved for those labor costs that can be essentially traced to
individual units of products. Direct labor is sometime called touch labor, since direct
labor workers typically touch the product while it is being made. Direct labour includes
worker working in
- Input Department
- Peeling department
- Washing department
- Slicing department
- Frying department
- Seasoning department
- Packaging Department

3. Manufacturing Overheads
Manufacturing overhead, the third element of manufacturing cost, includes all costs of
manufacturing except direct material and direct labor.
Variable manufacturing overheads includes
- Electricity
- Gas (gas generator)
- Nitrogen (N2) flush
- Utility expenses
- Repairing costs
- Maintenance costs
Fixed manufacturing overheads includes
- Rental costs (if gas generator is hired on rent)
- Transportation costs
- Meals
- Depreciation
Indirect labour includes
- Labour used in service department
- Security guards
- Labour in engineering department
- Warehousing labour

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 - Labour in quality department
- Overtime

Indirect material includes

- Food stickers

Non-Manufacturing costs:
Non manufacturing costs are those costs that are not incurred to manufacture a product.
Examples of such costs are salary of sales person and advertising expenses. Generally
non manufacturing costs are further classified into two categories.

1. Marketing and Selling Costs

2. Administrative Costs

1. Marketing & Selling Costs:

Marketing or selling costs include all costs necessary to secure customer orders and get
the finished product into the hands of the customers. These costs are often called order
getting or order filling costs. These costs include;

- Commissions
- Placement costs
- Transportation costs (per unit of product is charged)

2. Administrative costs

Administrative costs include all executive, organizational, and clerical costs associated
with general management of an organization rather than with manufacturing, marketing,
or selling. Examples of administrative costs include executive compensation, general
accounting, secretarial, public relations, and similar costs involved in the overall, general
administration of the organization as a whole. For PepsiCo, Snacks department following
costs are identified as its administrative costs;

- Salaries
- Office expenditure including furniture and stationery costs
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 - Depreciation costs (offices)

Cost classification on the basis of cost behaviour:

Apart from classifying costs as manufacturing and non-manufacturing costs, costs are
also classified on the basis of their behaviour. These are the
- Variable costs
- Fixed costs

1. Variable Costs

Variable cost is a cost that varies, in total, in direct proportion to changes in the level of
activity. In case of the manufacturing of Lays a number of variable costs are incurred.
The first is electricity cost. The electricity is generated from gas generators so the gas will
also be considered as a variable cost. 

2. Fixed costs

Fixed Cost is a cost that remains constant, in total, regardless of changes in the level of
activity within the relevant range. In case of the manufacturing of Lays the fixed costs
incurred are firstly the depreciation of the fixed assets being used. Second is the cost of
the permanent staff. The transportation cost i.e. cost of transporting potatoes from the
farm to plant and then from the plant to warehouse is also considered as a fixed cost. The
rental cost e.g. of the generators that are used to generate electricity is also fixed cost.

Other Costs:

Other costs include the fringe benefits and the extra benefits given to the employees.
Fringe benefits are perks offered to employees in order to keep them motivated and for
the purpose of retaining them.

Fringe benefits given to labour include

 Meal
 Transportation
 Overtime
Extra benefits to higher executives includes (varies with status)
 Pay roll
 Provident fund

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  Medical free facility
 Transport
 Fuel expense
 Cell phones (monthly bill of cell paid)

Lays and Process Costing:

The snacks department of PepsiCo undertakes the process costing system because;

- Identical units of products are being produced for a longer period of time on
continuous basis

- Costs are accumulated by departments

- Unit costs are computed by departments

Lays- Departments:

In production department, there are three main departments that involved in the
manufacturing of Lays potato chips. These include;

- Input department
- Processing department
- Packaging department (taping department)

Input Department:
Grade ”A” Potatoes are brought from farms owned by PepsiCo. Before putting them into
process they are first checked for quality inspection. And once approved they are put for
further processing.

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Processing department:

This department is further subdivided into 5 sub-departments;

- Washing

- Peeling

- Slicing

- Frying

- Seasoning

First the potatoes are thoroughly washed in water. Next the skin is gently peeled off so
that the flavor remains.  After which potatoes are thinly sliced and rinsed again to remove
any excess starch. Then the slices are cooked to a crispy crunch in all natural-oil. Lays
Classic Potato chips were cooked in hydrogenated oil until 2007. Currently, the chips are
made with 100% pure sunflower oil which is lower in saturated oil. Finally the chips are
topped with a sprinkle of salt or other seasonings.

Packaging:

The processed potatoes are packed into their respective packets. And before sealing the
packets Nitrogen flush is passed through the packets in order to maintain the life span of
the product to three to four months. Then these packets are sealed and packed into the
cartons. And finally these finished product inventory is sent to ware houses or purchase
points.

The Cost Flow System:

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The Direct materials, direct labor and manufacturing over head costs are transferred to
work in process account and from there it is then transferred to the finished goods
inventory.

The cost flow is further illustrated by the following sequence of diagrams.

1. to record the use of direct material

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 2. To record the direct labor costs

3. To apply manufacturing overhead to departments

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General assumptions undertaken by the company

- Labor is the fixed cost

- Discretionary fixed costs include

- R&D expenses

- Quality maintenance expenses

- Advertising expenses

- Committed fixed costs include

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 - Labor

- Contractual costs incurred as a result of contracts between distributors

Costing Procedures:

Both variable and absorption costing procedures are used. In PepsiCo they mainly focus
on variable costing approach which they use for decision making while the absorption
costing is used for analyzing the financial figures.

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