HUMBLE PIES
2014 AICPA Accounting Competition –
Management Accounting
Management
Accounting Case
Study: An Interactive
CGMA Business Game
Solution
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
2
Round 1: Costing System Recommendation
Executive summary:
1. What information does LP need?
LP competes through a differentiation strategy based on high quality candy, flavors and
packaging.
Because of its differentiation strategy, LP needs a cost system that can easily handle many
different types of pies for decisions relating to pricing, product offerings, and special orders.
Because all pies go through essentially the same production processes, the cost system does
not need to track the specific labor and overhead per individual pie or even order.
Overall, the cost system needs to provide accurate product costs for specific orders and
different types of pies within a wide variety of product combinations.
2. Which general costing approach do you recommend?
a. Pros and cons of the different costing approaches.
Job costing best captures the unique aspects of each job (especially the special ingredients or
flavor additives) and provides the most accurate cost per job. On the other hand, it would
require separate record-keeping for each job/order for all ingredients, labor, and overhead;
even though labor & overhead tend to be about the same for each pie.
Process costing would work well for labor and overhead as these cost are about the same for
each pie; probably the easiest and cheapest costing method for LP. However, it would not
capture the unique costs of special ingredients or different pie sizes for each order.
Operation costing would use job costing to track the unique costs of each order (esp. special
ingredients) and process costing to track labor and overhead as these costs are similar for
each pie. On the downside, it might be less accurate than job order costing for labor and
overhead costs; it would also be more complex than either job or process costing alone
because it requires the use of both methods.
Activity-based costing provides the most accurate assignment of overhead costs to products
assuming appropriate activity cost pools and drivers are chosen. However, LP would still need
to use job, process, or operation costing to account for direct costs. Using ABC would
probably be the most complex costing approach for LP to set up and maintain. There may not
be enough diversity in activities among products to justify the use of ABC.
b. Which approach do you recommend for direct costs? How would you assign indirect costs
to products?
Direct costs: More than one viable answer is possible here. The key point is to address the
pros and cons of each potential method and support the recommended approach. A simple
operation costing approach may be the most viable costing approach for direct costs at LP.
All pies go through essentially the same production processes but the pie size,
ingredients, flavors, and ingredient additives often vary by batch. Operation costing
would treat the labor and overhead as homogenous costs by process area using process
costing. The cost of ingredients and any special additives would be identified by order or
batch using job costing.
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
3
Indirect costs: LP probably does not have the staff or information systems to implement ABC
at this time. Perhaps LP could at least track overhead costs by process area to allocate it
more accurately than using a simple plantwide rate. In the future, as the company grows,
perhaps a simple ABC model could be added to improve the accuracy of overhead cost
assignment.
c. Product verses period costs. For accounting purposes, product costs include those costs
necessary to make the product (i.e., direct materials, direct labor, and factory overhead).
However, for decision making, management can assign any cost to the product that can be
traced directly to the product. In this case, with the possible exception of broker’s
commissions, LP may want stick with assigning DM, DL, and FOH as product costs as follows:
Cost Category
Product
Raw Materials
$327,934
Bakery labor
158,767
Administration Salaries (incl. taxes and benefits)
41,367
Supplies (e.g., spices, spoons, packaging)
3,833
Freight & Shipping-In
4,907
Freight & Shipping-Out
64,707
Utilities Electricity
9,813
Utilities Gas (ovens)
3,067
Water
920
Repairs & Maintenance
4,293
Rent expense (Building; 85% production, 15% admin)
16,292
Telephone & Internet (administrative)
0
CEO salary
0
Brokers’ commissions (4% of sales)
0
Total Expenses
$635,900
Cost Category
Track by:
Assign to Products:
Raw Materials
By product type (average cost)
Standard cost
Bakery labor:
By operation:
1. Production (incl. mix, pour,
bake, freeze)
By batch or product type
Direct cost per unit
2. Decoration & Packaging
By specific job
Direct cost per unit
3. Support (sanitation,
warehouse, or other)
As "Support labor"
Based on weight or labor hrs
Supplies
(e.g., spices, spoons, etc)
By operation:
1. Production (incl. mix, pour,
bake, freeze)
"Production supplies"
Based on production hours
2. Packaging (incl. decorating)
"Packaging supplies"
Based on packaging hours
3. Support (sanitation and
warehouse)
"Support supplies"
Based on weight or labor hrs
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
4
Cost Category
Track by:
Assign to Products:
Other Overhead Costs:
1. Freight & Shipping-In
Assign to raw materials cost
Based on materials cost
2. Gas & Electric (Dishwasher,
ovens)
Based on weight or labor hrs
3. Rent expense
Separate into Production vs.
Admin
Based on weight or labor hrs
4. Repairs & Maintenance
Based on weight or labor hrs
5. Utilities
Separate into Production vs.
Admin
Based on weight or labor hrs
6. Water
Based on weight or labor hrs
3. How to collect the information:
a. Labor costs. Create a simple log sheet for each labor area indicating the worker’s name, date,
and hours worked, and total pies completed. These logs would be totaled at the end of each
month and an average cost per pie computed for each area.
b. Supplies and other overhead costs. Create a separate log sheet to track indirect materials,
supplies, and other overhead costs by area. These logs would also be totaled at the end of
each month and an average cost per pie computed for each area.
c. Flavors and Ingredients. Develop a job cost sheet to track flavor additives and ingredient
costs by job or order. The costs of flavor additives might be added to overhead costs and
allocated to the pies whereas ingredients could be included with direct costs and traced to
each order.
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
5
Round 2: Evaluate Two Investment Opportunities
Option 1: Fast Food Chain
The fast food chain offer guarantees a 3-year agreement with the possibility of extension depending
on the success of the agreement. As the following analysis shows, the agreement is estimated to
increase profits by $495K for the 3-year contract (ROI 33%). If the agreement is extended to 6 years,
profits will increase by $990K (ROI per year 33%). Linda’s Pies currently has an annual ROI of 10.3%*.
Thus, the fast food chain order would increase both profits and ROI for LP even if only for 3 years.
* LP’s current ROI = ($47,346 x 12 mos.) ÷ $5.5 million operating assets = 10.3%
Price/unit
$1.50
$1.50
volume
2,200,000
4,400,000
Investment
$500,000
$500,000
Margin %:
15%
15%
Time frame (months):
36
72
Incremental Revenues
$3,300,000
$6,600,000
Incremental Costs
$2,805,000
$5,610,000
Incremental Profit
$495,000
$990,000
Incr. Profit/year
$165,000
$165,000
ROI (per year)
33.0%
33.0%
Payback period (years)
3.03
3.03
Option 2: Labelling machine
The labelling machine option provides both labor savings per month plus additional throughput. As
the following analysis shows, this option is estimated to increase profits by $1 million for the 5-year
estimated life of the machine (ROI per year 40%). If the machine life is extended, profits will increase
by approximately $200,000 per year. Linda’s Pies currently has an annual ROI of 10.3% (see above).
Thus, the labelling machine would increase both profits and ROI for LP for at least 5 years and
maybe longer.
Savings per month
$14,500
$14,500
Additional throughput/mo
$13,000
$13,000
Investment
$500,000
$500,000
Markup %:
20%
20%
Time frame (months):
60
72
Incremental Savings
$870,000
$1,044,000
Incremental Revenues
$780,000
$936,000
Incremental Costs
$650,000
$780,000
Incremental Profit
$1,000,000
$1,200,000
Incr. Profit/year
$200,000
$200,000
ROI (per year)
40.0%
40.0%
Payback period (years)
2.50
2.50
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
6
Profitability and ROI:
Both options would be profitable for LP and increase ROI. Ideally, it would be nice if LP could
implement both options.
If LP is only able to implement one option at this time, the labelling machine provides a 40% ROI
versus only 33% for the fast food chain option’s 3-year contract. If the contract is extended
beyond the useful life of the labelling machine, however, it may be more profitable in the long
run.
Strategic, technical, behavioral, and risk factors: There are several other factors that LP needs to
consider here, including the following:
Strategic factors:
o Will the fast food chain be reliable for the contract? Will they change prices after 3 years?
o Can we negotiate with the fast food management?
o Will the fast food chain offer affect relationships with our other customers? Will they
expect reduced prices?
o Which option helps or hurts our long-term strategic plans?
o Will the fast food option lead to other fast food chain opportunities?
o Will the labelling machine option lead to new product opportunities?
o Will the labelling machine affect how our target customers will perceive us?
o Will be able to maintain high quality with the fast food option?
o Will be able to maintain high quality with the labelling machine option?
Technical factors:
o Will LP have to share proprietary information (e.g., recipe, production methods, etc.) with
the fast food chain?
o Will the labelling machine be reliable? Will it require higher maintenance costs?
Behavioral factors:
o Conflicts can arise between management incentives and company goals. Are there
incentive differences between the two options?
o Will the fast food contract lead to less motivation to innovate or find new market outlets
than if the labelling machine option is taken?
Risk factors:
o How likely is the fast food agreement likely to be extended?
o Is the fast food chain going to be successful during the agreement? Is LP at risk if the fast
food chain experiences lower customer volume?
o Will the labelling machine last the full five years?
o Payback period is shorter for the labelling machine (2.5 years) than for the fast food option
(3.0 years).
o How confident are we that the labelling machine will save an estimated $14,500 per month
in labor cost and increase throughput by $13,000 revenues per month?
Recommendation: More than one viable answer is possible here. The key point is to address the
pros and cons of each option and support the recommended action.
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
7
Round 3: Evaluate Two Strategic Alternatives
1. Pete’s Steakhouse:
See analysis on p. 8. Treats 2012 as “Budget” and 2013 as “Actual.” Flexible budget based on
2013 customer volume and 2012 price and variable costs per meal.
A higher average price/meal ($9.87 vs. 9.51) had a favorable impact of $386K with a lower sales
volume unfavorable impact of $74.5K.
There may be cost control issues. Variable costs in 2013 were $299K unfavorable and fixed
operating costs $19K unfavorable.
Assuming that the average price/meal increases 12% with Linda’s Pies, operating profit for
Pete’s will increase to $1,172K, resulting in an ROI of 11.7%, residual income of $372K, and a
payback of 8.5 years.
2. Knoxville factory.
See analysis on p. 9. Uses May 2014 as guide for fixed costs per month and variable costs as a
percentage of sales.
Year 2015 for the new factory shows an operating loss of ($280K) and ROI of -2.8%.
The new factory barely becomes profitable in 2016 ($45K). In 2017, projected operating income
is almost $700K but ROI is only 7% and residual income shows an economic loss of ($101K).
Based on 2017 estimated results, operating profit for LP will increase by almost $700K per year
but ROI and residual income will decline. Payback is 14.3 years (plus 2 years = 16.3 years).
3. Strategic, technical, behavioral, and risk factors: There are several other factors that LP needs to
consider here, including the following:
Strategic factors:
o Will the Pete’s business be reliable for the foreseeable future?
o Can we negotiate with the Pete’s management?
o Will Pete’s Steakhouse business affect relationships with our other customers?
o Which option helps or hurts our long-term strategic plans?
o Will the Pete’s option lead to other Pete’s chain opportunities?
o Are we able to operate a restaurant chain? Our expertise is wholesale foods.
o Will the new factory’s target customers perceive us differently?
o Will we be able to maintain high quality with the Pete’s option?
o Will be able to maintain high quality with the Knoxville factory option?
Technical factors:
o Will LP have to share proprietary information (e.g., recipe, production methods, etc.) with
the Pete’s restaurant chain?
o Can Pete’s management team operate the chain for us?
o Will the new factory be reliable? Will it require higher maintenance costs?
Behavioral factors:
o If Pete’s management team runs the restaurant chain for us, what incentives are
necessary?
o Will the Pete’s contract lead to less motivation to innovate or find new market outlets than
if the Knoxville factory option is taken?
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
8
Risk factors:
o How likely is the new Pete’s Steakhouse average price/meal assumption?
o Is demand for Pete’s Steakhouse going to be strong during the next 10 years? Is LP at
risk if Pete’s experiences lower customer volume?
o Will the Knoxville Factory business increase as estimated? How long?
o Payback period is much shorter for the Pete’s option (8.5 years) than for the new factory
option (16.3 years).
Recommendation:
There are significant risks for both options. Could go either way.
Pete’s Steakhouse option is much more profitable in the near future, but can Linda’s Pies
operate a restaurant chain successfully? May need Pete’s management team to run the chain
for us.
The Knoxville Factory option is less profitable in the short term, but perhaps in the long-term it
will double the current business. We are already familiar and successful with this business.
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
9
Option 1: Pete's Steakhouse
Profit performance analysis:
2013 Actual
Price /
Spending
Flex. Budget
Sales
Volume
Budget
(2012 Actual)
Per unit
Customer volume
1,066,000
1,066,000
1,105,000
Net sales
$10,523,440
$385,809
$10,137,631
($370,889)
$10,508,520
$9.51
Variable costs:
Food
6,340,206
($202,002)
$6,138,204
$224,568
6,362,772
$5.76
Labor
696,612
($20,994)
$675,618
24,718
700,336
$0.63
Other Op Exp
1,362,399
($75,770)
$1,286,629
47,072
1,333,701
$1.21
Total Var. Costs
8,399,217
($298,766)
8,100,451
296,358
8,396,809
$7.60
Contribution Margin
2,124,223
$87,043
2,037,180
(74,531)
2,111,711
$1.91
Fixed Costs:
Labor
298,548
$1,596
300,144
$0
300,144
Other Op Exp
908,266
($19,132)
889,134
$0
889,134
Total Fixed Costs
1,206,814
($17,536)
1,189,278
$0
1,189,278
Operating Profit
$917,409
$69,507
$847,902
($74,531)
$922,433
Average price/meal
$9.87
$9.51
$9.51
Estimated 2014 (with Linda's Pies):
Increased price/meal
12%
Revised price/meal
$11.06
Net sales
$11,786,253
Variable costs:
Food
7,101,031
Labor
780,206
Other Op Exp
1,525,887
Total Variable Costs
9,407,123
Contribution Margin
2,379,129
Fixed Costs:
Labor
298,548
Other Op Exp
908,266
Total Fixed Costs
1,206,814
Operating Profit
$1,172,315
Investment Required
$10,000,000
Margin
9.9%
Turnover
1.2
ROI
11.7%
Residual Income
$372,315
Payback Period (years)
8.5
2014 AICPA Accounting Case Competition: Linda’s Pies (A Solution)
10
Option 2: Knoxville Factory
Current LP
Current LP
Knox.
Factory
Knox.
Factory
Knox.
Factory
Knox.
Factory
Knox.
Factory
Knox.
Factory
Cost Category
May 2014
2015
2015
2016
2016
2017
2017
Sales
$766,667
100.00%
$4,000,000
100.00%
$6,000,000
100.00%
$10,000,000
100.00%
Less Cost of Goods Sold:
Variable mfg costs
$551,948
71.99%
$2,879,727
71.99%
$4,319,591
71.99%
$7,199,319
71.99%
Fixed mfg costs
$83,952
10.95%
$1,007,423
25.19%
$1,007,423
16.79%
$1,007,423
10.07%
Total Cost of Goods Sold
635,900
82.94%
3,887,151
97.18%
5,327,015
88.78%
8,206,742
82.07%
Gross Margin
130,767
17.06%
112,849
2.82%
672,985
11.22%
1,793,258
17.93%
Less S&A costs:
Variable
$30,667
4.00%
$160,002
4.00%
$240,003
4.00%
$400,004
4.00%
Fixed
$30,475
3.98%
$365,701
9.14%
$365,701
6.10%
$365,701
3.66%
Total S&A costs
$61,142
7.98%
$525,702
13.14%
$605,703
10.10%
$765,705
7.66%
Operating Profit
$69,625
9.08%
(412,853)
-10.32%
$67,282
1.12%
$1,027,553
10.28%
Income Tax
22,280
2.91%
(132,113)
-3.30%
21,530
0.36%
328,817
3.29%
Net operating income
$47,345
6.18%
(280,740)
-7.02%
$45,752
0.76%
$698,736
6.99%
Other Data:
Unit volume
64,500
336,522
504,782
841,304
Average operating assets
$5,500,000
$10,000,000
$10,000,000
$10,000,000
Min. Rate of Return
8.00%
8.00%
8.00%
8.00%
Average price/pie
$11.89
$11.89
$11.89
$11.89
Margin
6.2%
-7.0%
0.8%
7.0%
Turnover
1.7
0.4
0.6
1.0
ROI
10.3%
-2.8%
0.5%
7.0%
Residual Income
$128,140
($1,080,740)
($754,248)
($101,264)
Payback Period (years)
14.31