multi-part question

Three Broomsticks Café

The Three Broomsticks Café, a popular restaurant in Hogsmeade, has only one menu item, three pieces of chicken with fries, which sells for $5 per serving. [footnoteRef:1] The owner, Madam Rosmerta, is considering a number of changes: “We have kept good records of profitability, as every month we look at what has happened with our revenues and costs. However, I am having trouble using that information to predict what will happen if we start to make major changes in the way we run the business, and I have a list of changes that I am considering. I guess as a starting point, I just need to know what it costs to make a serving of chicken and fries. Right now, I don’t even have a handle on that basic information.” [1: For ease of use, financial statements throughout have been translated from Galleons to USD.]

Exhibit 1 summarizes Three Broomsticks’ information about profitability, revenue, and costs based on averages from the past three years. Direct Materials (DM) includes the food items required to produce the menu. Direct Labor (DL) includes the cost of the store manager and hourly employees. Overhead (OH) includes a variety of indirect costs (condiments, paper products, cooking oil, and batter) that tend to vary with the volume of product produced. Other overhead items include costs that do not vary with respect to volume (rent on the building and equipment). The following paragraphs provide additional detailed information about each category of costs (also see Exhibit 1).

Direct Materials for the Three Broomsticks’ basic menu consists of two main inputs: Chicken and potatoes. Chicken arrives from suppliers and is stored frozen. Each morning chicken is thawed to meet the anticipated needs of the day. Whole fresh potatoes are washed, peeled, hand-cut, and blanched each day to prepare potatoes that are ready to be fried. Unsold food is discarded at the end of the day.

Direct Labor to prepare and sell the chicken and fries and maintain the store is provided by a store manager with a salary of $3,500 per month, and by hourly employees at a cost of $8.00 per hour (including all payroll costs). Hourly employees work a minimum of four hours and a maximum of eight hours per shift, and the schedule is arranged to overlap during the peak lunch and dinner periods. The store is open from 11:00 am to 9:00 pm seven days a week, and work hours extend from two hours before opening time (when prep work is done) to one hour after closing (when cleanup and closing activities are completed). Madame Rosmerta keeps the Three Broomsticks well-staffed, so even at the busiest times employees could handle more business. The store manager typically works about 200 hours per month with the remainder of the hours provided by hourly employees. In addition to scheduling, personnel, and other managerial duties, managers perform all the duties of hourly employees (including food preparation, sales, and cleanup), as needed.

Overhead includes condiments, paper products, cooking oil, and batter for the chicken. Condiments include salt, pepper, ranch dressing, and ketchup. Paper products include napkins, serving boats, straws, and miscellaneous other items. Cooking oil is used in the frying pots. Batter for the chicken comes as dry mix and is mixed in small batches several times each day as needed. Madame Rosmerta believes that these costs vary closely, though not perfectly, with the dollar volume of sales. Overhead also includes rent for equipment and the building.

Following are Madam Rosmerta’s descriptions of the changes she is considering:

1. “Every day, about 15 minutes before the close of business, we fry all the remaining thawed chicken and blanched potatoes. Most days, that leaves us with leftover chicken and fries at closing. Our current policy is to throw away all unsold product. However, I am thinking about changing the policy so that leftovers are sold (either to customers or employees) at closing at a discounted price. I hate to be wasteful and throw away perfectly good food.”

2. “Like most fast food restaurants, the bulk of our business comes during a one-hour period at the lunch rush and another one-hour period at the dinner rush. We can cook a small amount of product in advance of the rush periods, but chicken and fries that are more than a few minutes old don’t meet our quality standards. Right now, the amount we can cook and serve is constrained by our fryer capacity – we can fry only about 40 servings per hour using our current fryer. Because we lose some business from customers who drive up and see our long waiting lines, I am considering replacing our fryer with a larger one that would increase our maximum output to 50 servings per hour. Our current fryer costs $300 per month to rent, and the larger capacity fryer would cost $550 per month. But the use of this new fryer requires more expensive oil, which will cost us another $0.10/per serving.”[footnoteRef:2] [2: Assume Three Broomsticks is open 30 days per month.]

3. “I frequently get requests from customers to provide catering services for large lunch or dinner orders but we don’t currently take reservations – customers with a large order have to wait in line like everyone else. Because of this, I think we are losing out on quite a bit of business. I am thinking of instituting a new policy where the customers could call in their orders and we would have them prepared and delivered at whatever time customers request. One of the messenger services has offered to deliver orders for a fixed fee of $10 per order (we would require a minimum order size of 10 servings). I estimate we would do about $1,000 per month (i.e., 200 servings per month) of these pre-arranged orders, where the average order size would be 20 servings per order.”

Exhibit 1: Three Broomsticks Café Monthly Revenues and Costs (Averaged Over Previous 36 Months)
Sales	$22,500
Chicken	7,875
Potatoes	270
Manager Salary	3,500
Hourly Wages	5,270
Condiments, Paper, Oil, Batter	630
Rent	1,100

Required:

1. What do you think is the cost of a serving of chicken and fries? Provide an explanation to Madame Rosmerta supporting your cost analysis. Explain any assumptions included in your calculations.

2. Make a recommendation regarding each of Madam Rosmerta’s proposed changes. Consider each proposed change independently. You will likely need to make some additional assumptions, so be sure to outline your important assumptions and explain their effects on your recommendations. You should address the following in your recommendations:

a. For scenario 1, what is the minimum price for which Madam Rosmerta can sell leftovers and still make a profit? Explain your recommendation to Madam Rosmerta.

b. For scenario 2, what is the expected incremental effect on monthly profit? How many additional servings would Three Broomsticks have to sell in order for the monthly profit with the new fryer to equal the monthly profit with the current fryer? Explain your recommendation to Madam Rosmerta.

c. For scenario 3, what is the expected incremental effect on monthly profit? Explain your recommendation to Madam Rosmerta.

[please type your response here]

Trelawney Cloak Production

Ron Weasley, controller of the Trelawney Cloak Production Company, was concerned about the recent financial trends in operating results. Several years earlier, Sybill Trelawney, CEO, had seen opportunities to expand the product line from just two cloaks, blue and black, to four cloaks, adding red and purple cloaks. But Ron had seen financial results from the most recent fiscal year (see Exhibit 1), and was disappointed. Having just received his TMMBA from the University of Washington, Ron knew about activity-based costing and set about a cost study.

Ron first identified six categories of support expenses that were currently being allocated to cloak production:

Expense category	Expense amount ($)
Indirect labor	$20,000
Fringe benefits	16,000
Computer systems	10,000
Machinery depreciation	8,000
Maintenance	4,000
Energy	2,000
Total	$60,000

Ron determined that fringe benefits were 40% of labor expenses (both direct and indirect) and would thus represent just a percentage markup applied on top of direct and indirect labor charges. Ron interviewed department heads in charge of indirect labor and found that three main activities accounted for their work. About half of indirect labor time was involved in scheduling or handling production runs.

Another 40% of indirect labor time was required just for the physical changeover from one type of cloak to another. The time to change over to black cloaks was relatively short, but other cloaks required longer changeover times due to the use of multiple thread colors. Red cloaks, having the most colored embroidery, required the most extensive changeover.

The remaining 10% of the time was spent maintaining records on the four products, and equal time was spent on each product.

Ron also collected information on potential activity cost drivers for Trelawney’s activities (see Exhibit 2) and the distribution of the cost drivers for each of the four products.

Next, Ron turned his attention to the company’s computer system operation costs. He interviewed IT managers and found that about 80% of computing resources were devoted to production run activity, and the remaining 20% was devoted to keeping records on each of the four products. Again, records maintenance took about the same amount of time for each product.

Finally, after extensive interviews, Ron concluded that the remaining three categories of overhead expense we incurred to supply machine capacity to produce the cloaks. The machines had practical capacity of 10,000 hours of productive time that could be supplied to cloak production.

Exhibit 1: Traditional Income Statement
	Blue	Black	Red	Purple	Total
Sales	$75,000	$60,000	$13,950	$1,650	$150,600
Material costs	25,000	20,000	4,680	550	50,230
Direct labor	10,000	8,000	1,800	200	20,000
Overhead at 300%	30,000	24,000	5,400	600	60,000
Net operating income	$10,000	$8,000	$2,070	$300	$20,370
Return on sales	13.3%	13.3%	14.8%	18.2%	13.5%

Exhibit 2: Direct Costs and Activity Cost Drivers
	Blue	Black	Red	Purple	Total
Production sales volume	50,000	40,000	9,000	1,000	100,000
Unit selling price	1.50	1.50	1.55	1.65
Materials (unit cost)	0.50	0.50	0.52	0.55
Direct labor hours/unit	0.02	0.02	0.02	0.02	2,000
Machine hours/unit	0.10	0.10	0.10	0.10	10,000
Production runs	50	50	38	12	150
Setup time/run	4	1	6	4	15
Total setup time (hours)	200	50	228	48	526

Required:

1. Calculate the revised product profitability for the four cloaks based on the activity information Ron gathered.

2. Compare the product profitability in Exhibit 1 to the profitability you calculated in item 1. What causes any apparent shifts in profitability between the two cost systems?

3. What actions might be stimulated by the ABC exercise?

4. Which system do you recommend Ron use in the future? Why?

[please type your response here]

Gladrags Wizardwear Group Ltd.

Gladrags Wizardwear Group, a well-known manufacturer of wizard attire, is planning to market a new wizarding robe for the coming season. Gladrags Wizardwear Group supplies retailers in Europe and the United States.

Four yards of material are required to lay out the robe pattern. Some material remains after cutting. This leftover material can either be sold as remnants or it can be used to manufacture a matching hat and wand pouch. However, if the leftover material is to be used to manufacture the hat and wand pouch, the cutting of the robe pattern must be done more precisely, which increases cutting costs.

Gladrags plans to sell the hat and wand pouch as matching accessories with the robe; they will not be sold individually. Market research indicates that Gladrags can expect to sell 1,250 robes if matching hats and wand pouch are not available. Robe sales are expected to be 20% higher if matching hats and wand pouches are available.

The breakdown of expected sales of robes, hats, and wand pouches is:

	Number
Complete sets of robe, hat, and wand pouch	1,050
Robe and hat	90
Robe and wand pouch	225
Robe only	135
Total	1,500

The material used in the robe costs $80 per yard. The cutting cost if the hat and wand pouch are not manufactured is estimated to be $100 a robe, and the resulting remnants can be sold for $28 for each robe cut out. The cutting cost if the hat and wand pouch are manufactured is estimated to be $130 per robe.

The selling prices and the costs to complete each of the three items once they are cut are as follows:

	Selling Price (per unit)	Unit Cost to Complete (Excludes Costs of Material and Cutting Operation)
Robe	$1,050	$400
Hat	140	100
Wand pouch	50	30

Required:

1. Should Gladrags manufacture the hats and wand pouches in conjunction with the robes? Show your calculation of the incremental profit or loss from manufacturing the hats and wand pouches rather than selling the remnants.

2. Identify any qualitative factors that could influence the company’s management in its decision to manufacture hats and wand pouches that match the robes.

[please type your response here]

Scrivenshaft Quills

Consider the following details of the most recent annual income statement for Scrivenshaft Quills.

Scrivenshaft Quills Profit and Loss Statement 2012
Sales	$16,200
Less cost of goods sold	9,450
Gross margin	$6,750
Less selling and administrative expenses	4,350
Operating income	$2,400

Scrivenshaft’s fixed manufacturing costs were $3,600 and its fixed selling and administrative expenses were $3,300. In the most recent year, Scrivenshaft produced and sold 3,000 quills. Sales commissions were 3% of sales and are included in selling and administrative expenses.

Near the end of the year, Hogwarts offered to buy 140 quills on a special order for $610. Hogwarts requested that a secret logo be engraved on each quill. Scrivenshaft would be required to purchase special engraving equipment, costing $50, to complete the order. Moreover, the engraving would cost an additional $.25 per quill in labor.

Even though Scrivenshaft had some excess capacity, Felicia Scrivenshaft, CEO, rejected the Hogwarts offer, saying, “[t]he Hogwarts offer is simply too low. We’d avoid paying sales commissions, but, even so, the offer doesn’t cover our per-unit cost of $4.60 per quill, much less the additional cost of engraving and engraving equipment. Plus, we’d have other customers wanting special deals if word got out.”

Required:

1. Evaluate Ms. Scrivenshaft’s statement. Are there any flaws in her assumptions? How much do you believe the profit or loss on the Hogwarts offer would be?

2. What would you advise Ms. Scrivenshaft to do? Why?

[please type your response here]

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