This is a conversation between Joe, the owner of a restaurant, and an “efficiency expert” “EFF EX”. Joe has placed a stand which is placed next to the cash register and it is used to display and sell bags of peanuts. Soon after that this conversation takes place.EFF EX: Joe, you said you put in these peanuts because some people ask for them, but do you realize what this rack of peanuts is costing you?JOE: It ain’t gonna cost. ‘Sgonna be a profit. Sure, I hadda pay $25 for a fancy rack to hold bags, but the peanuts cost 6¢ a bag and I sell ’em for 10¢ . Figger I sell 50 bags a week to start. It’ll take 12 ½ weeks to cover the cost of the rack. After that I gotta clear profit of 4¢ a bag. The more I sell, the more I make.EFF EX: That is an antiquated and completely unrealistic approach, Joe. Fortunately, modern accounting procedures permit a more accurate picture which reveals the complexities involved.JOE: Huh?EFF EX: To be precise, those peanuts must be integrated into your entire operation and be allocated their appropriate share of business overhead. They must share a proportionate part of your expenditure for rent, heat, light, equipment depreciation, decorating, salaries for your waitresses, cook…JOE: The cook? What’s he gotta do wit’a peanuts? He don’ even know I got ’em!EFF EX: Look, Joe, the cook is in the kitchen, the kitchen prepares the food, the food is what brings people in here, and the people ask to buy peanuts. That’s why you must charge a portion of the cook’s wages, as well as a part of your own salary to peanut sales. This sheet contains a carefully calculated cost analysis which indicates the peanut operation should pay exactly $1,278 per year toward these general overhead costs.JOE: The peanuts? $1,278 a year for overhead? The nuts?EFF EX: It’s really a little more than that. You also spend money each week to have the windows washed, to have the place swept out in the mornings, keep soap in the washroom, and provide free cokes to the police. That raises the total to $1,313 per year.JOE: (Thoughtfully) But the peanut salesman said I’d make money… put ’em on the end of the counter, she said… and get 4¢ a bag profit…EFF EX: (With a sniff) He’s not an accountant. Do you actually know what the portion of the counter occupied by the peanut rack is worth to you?JOE: Ain’t worth nothing – no stool there…Just a dead spot at the end.EFF EX: The modern cost picture permits no dead spots. Your counter contains 60 square feet and your counter business grosses $15,000 a year. Consequently, the square foot of space occupied by the peanut rack is worth $250 per year. Since you have taken that area away from general counter use, you must charge the value of the space to the occupant.JOE: You mean I gotta add $250 a year more to the peanuts?EFF EX: Right. That raises their share of the general operating costs to a grand total of $1,563 per year. Now then, if you sell 50 bags of peanuts per week, these allocated costs will amount to 60¢ per bag.JOE: What?EFF EX: Obviously, to that must be added your purchase price of 6¢ per bag, which brings the total to 66¢. So you see, by selling peanuts at 10¢ per bag, you are losing 56¢ on every sale.JOE: Something’s crazy!EFF EX: Not at all! Here are the figures. They prove your peanuts operation cannot stand on its own feet.JOE: [Brightening] Suppose I sell lotsa peanuts…thousand bags a week ‘stead of fifty.EFF EX: [Tolerantly] Joe, you don’t understand the problem. If the volume of peanuts sales increases, our operating costs will go up … you’ll have to handle more bags with more time, more depreciation, more everything. The basic principle of accounting is firm on that subject: “The Bigger the Operation, the More General Overhead Costs That Must Be Allocated.” No, increasing the volume of sales won’t help.JOE: Okay, you so smart, you tell me what I gotta do.EFF EX: [Condescendingly] Well… you could first reduce operating expenses.JOE: How?EFF EX: Move to a building with cheaper rent. Cut salaries. Wash the windows biweekly. Have the floor swept only on Thursday. Remove the soap from the washrooms. Decrease the square-foot value of your counter. For example, if you can cut your expenses 50 percent, that will reduce the amount allocated to peanuts from $1,563 to $781.50 per year, reducing the cost to 36¢ per bag.JOE: [Slowly] That’s better?EFF EX: Much, much better. However, even then you would lose 26¢ per bag if you only charge 10¢. Therefore, you must also raise your selling price. If you want a net profit of 4¢ per bag you would have to charge 40¢.JOE: [Flabbergasted] You mean even after I cut operating costs 50 percent I still gotta charge 40¢ for a 10¢ bag of peanuts? Nobody’s that nuts about nuts! Who’d buy ’em?EFF EX: That’s a secondary consideration. The point is, at 40¢ you’d be selling at a price based upon a true and proper evaluation of your then reduced costs.JOE: [Eagerly] Look! I gotta better idea. Why don’t I just throw the nuts out…put ’em in the ashcan?EFF EX: Can you afford it?JOE: Sure. All I got is about 50 bags of peanuts…cost about three bucks…so I lose $25 on the rack, but I’m outa this nutsy business and no more grief.EFF EX: [Shaking head] Joe it isn’t that simple. You are in the peanut business! The minute you throw those peanuts out you are adding $1,563 of annual overhead to the rest of your operation. Joe…be realistic…can you afford to do that?JOE: [Completely crushed] It’s unbelievable! Last week I was making money. Now I’m in trouble…just because I think peanuts on a counter is gonna bring me some extra profit…just because I believe 50 bags of peanuts a week is easy.EFF EX: [With raised eyebrow] That is the object of modern cost studies, Joe…to dispel those false illusions.Required Questions1. Is Joe losing 56¢ on every sale of peanuts? Explain.2. Do you agree that if the volume of peanut sales is increased, operating losses will increase? Explain.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.4. Do you think that Joe can afford to get out of the peanut business? Give reasons.5. Do you think that Joe should eliminate his peanut operations? Why or why not?
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