HOTEL COSTING

MODULE 1 COST CONCEPTS

Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the
cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for
recognizing, classifying, allocating, aggregating and reporting such costs and comparing them with standard
costs."
Elements of cost accounting
Basic cost elements are:

1. Material
2. Labour
3. Expenses and other overheads
Material (Inventory)
The materials directly contributed to a product and those easily identifiable in the finished product are
called direct materials. For example, paper in books, wood in furniture, plastic in a water tank, and leather in
shoes are direct materials. Other, usually lower cost items or supporting material used in the production of in a
finished product are called indirect materials. For example, the length of thread used in a garment.
Furthermore, these can be categorized into three different types of inventories that must be accounted for in
different ways; raw materials, work-in-progress, and finished goods.[5]
Labour
Any wages paid to workers or a group of workers which may directly co-relate to any specific activity of
production, maintenance, transportation of material, or product, and directly associate in the conversion of raw
material into finished goods are called direct labour . Wages paid to trainee or apprentices does not come under
the category of direct labour as they have no significant value.
Overheads
Overheads include:

 Production or works overhead including factory staff

 Administration overhead including office staff
 Sales overhead including production and maintenance of catalogues, advertising (development and
purchases), exhibitions, sales staff, cost of money
 Distribution overhead
 Maintenance and repair including office equipment and factory machinery
 Supplies
 Utilities including gas, electric, water, sewer, and municipal assessments
 Other variable expenses
 Salaries/payroll including wages, pensions, and paycheck deductions (e.g., NI and PAYEE in the UK,
FICA in the US)
 Occupancy (rent, mortgage, property taxes)
 Depreciation (durable goods including machinery and office equipment)
 Other fixed expenses
These categories are flexible and sometimes overlapping. For example, in some companies, machine cost is
segregated from overhead and reported as a separate element altogether, and payroll costs are sometimes
separated from other production costs.

Classification of costs
Classification of cost means, the grouping of costs according to their common characteristics. The important
ways of classification of costs are:

1. By Nature or Traceability: Direct Costs and Indirect costs. Direct Costs are directly
attributable/traceable to Cost object. Direct costs are assigned to Cost Object. Indirect Costs are not
directly attributable/traceable to Cost Object. Indirect costs are allocated or apportioned to cost
objects.
 2. By Functions: production, administration, selling and distribution, R&D.
3. By Behavior: fixed, variable, semi-variable. Costs are classified according to their behaviour in relation
to change in relation to production volume within a given period of time. Fixed Costs remain fixed
irrespective of changes in the production volume in a given period of time. Variable costs change
according to the volume of production. Semi-variable costs are partly fixed and partly variable.
4. By control ability: controllable, uncontrollable costs. Controllable costs are those which can be
controlled or influenced by conscious management action. Uncontrollable costs cannot be controlled
or influenced by conscious management action.
5. By normality: normal costs and abnormal costs. Normal costs arise during routine day-to-day business
operations. Abnormal costs arise because of any abnormal activity or event not part of routine business
operations. E.g. costs arising of floods, riots, accidents etc.
6. By Time: Historical costs and predetermined costs. Historical costs are costs incurred in the past.
Predetermined costs are computed in advance on basis of factors affecting cost elements. Example:
Standard Costs.
7. By Decision making Costs: These costs are used for managerial decision making. And these are :
1. Marginal costs: Marginal cost is the change in the aggregate costs due to change in the volume
of output by one unit.
2. Differential costs: This cost is the difference in total cost that will arise from the selection of
one alternative to the other.
3. Opportunity costs: It is the value of benefit sacrificed in favour of an alternative course of
action.
4. Relevant cost: The relevant cost is a cost which is relevant in various decisions of
management.
5. Replacement cost: This cost is the cost at which existing items of material or fixed assets can
be replaced. Thus this is the cost of replacing existing assets at present or at a future date.
6. Shutdown cost: These costs are the costs which are incurred if the operations are shut down
and they will disappear if the operations are continued.
7. Capacity cost: These costs are normally fixed costs. The cost incurred by a company for
providing production, administration and selling and distribution capabilities in order to
perform various functions.
8. Sunken cost: cost already incurred
9. Other costs

Objectives of Cost Accounting

The objective of the cost accounting is to determine the methods by which expenditure on materials, wages and
overhead are recorded, classified and allocated. This is necessary so that the
cost of products and services may be accurately ascertained. Thus, the following are the main objectives of cost
accounting:

1. Ascertainment of the cost per unit of the different products that a business concern manufacturers.
2. To correctly analyze the cost of both the process and operations.
3. Disclosure of sources for wastage of material, time, expenses or in the use of the equipment and the
preparation of reports which may be necessary to control such wastage.
4. Provide requisite data and help in fixing the price of products manufactured or services rendered.
5. Determination of the profitability of each of the products and help management in the maximization of
these profits.
6. Exercise effective control of stocks of raw material, work-in-progress, consumable stores, and finished
goods so as to minimize the capital invested in them.
7. Present and interpret data for management planning, decision-making, and control.
8. Help in the preparation of budgets and implementation of budgetary control.
9. Aid management in the formulation and implementation of incentive bonus plans on the basis of
productivity and cost savings.
10. Organization of cost reduction programmes with the help of different departmental managers.
11. To provide specialized services for cost audit in order to prevent errors and frauds.
12. To facilitate prompt and reliable information to management.
13. Determination of costing profit or loss by linking the revenues to costs of those products or services by
selling which the revenues have arisen.
Scope or functions of cost accountancy are:
 1. Cost Ascertainment
Cost Accountancy collects and analyses the expenses, measures the production of products at different stages of
manufacture and the links up of production with the expenses. It thus calculates or ascertains the Historical or Actual
costs, estimated costs, standard costs, etc.
It also uses the different techniques of costing such as marginal cost technique, the total cost technique, direct cost
technique, etc. to link the production with expenses.

2. Cost Accounting
Cost Accountancy is the process of accounting for cost. It begins with the recording of expenditure and ends with the
preparation of statistical data. Cost Accounting is a formal mechanism of ascertaining and controlling the costs of
products or services.
It is thus helpful to the management in decision making which also requires the costing information. However, if a
firm keeps cost and financial accounts separately then their reconciliation is also necessary so as to verify the
accuracy of both sets of accounts.

3. Cost control
Cost control refers to the regulation of the costs of operating an undertaking. It involves guiding the actual costs
towards the line of targets and regulating the actual in case they deviate or vary from the targets.
Cost control is done by executive action. The organization can control costs by means of standard costing, budgetary
control, proper presentation and reporting of cost data and cost audit.

Cost Sheet Format

A Cost Sheet depicts the following facts:

1. Total cost and cost per unit for a product.

2. The various elements of cost such as prime cost, factory cost, production cost, cost of goods sold, total cost,
etc.
3. Percentage of every expenditure to the total cost.
4. Compare the cost of any two periods and ascertain the inefficiencies if any.
5. Information to management for cost control
6. Calculate and summarize the total cost of the product.

Objects of Cost Sheet

1. For determining the selling price

A cost sheet helps in determination of selling price of a product or of a service. Cost sheet ascertains cost at each
stage of the product and also the total cost of the product, where a margin of profit is added and thus the selling price
is ascertained.

2. Facilitating in managerial decision making

Preparation of cost sheet helps managers at various levels in their decision-making process such as

1. to produce or buy a component,

2. what price of goods to quote in the tender,
3. whether to retain or replace an existing machine,
4. how to reduce costs and maximize profit.
5. identify and make decisions whether they need to continue with the product or not.

3. Preparation of budgets
Organizations can prepare a budget with the help of a cost sheet. We can prepare the budget by using the current or
previous year’s data.
Based on our existing cost sheet, we can make estimates of our cost for the next financial year. It helps to prepare
and make the necessary arrangement of funds for costs of the next financial year

Elements of Cost
Prime Cost: It comprises of direct material, direct wages, and direct expenses. Alternatively, the Prime cost is the
cost of material consumed, productive wages, and direct expenses.
Factory Cost: Factory cost or works cost or manufacturing cost or production cost includes in addition to the prime
cost the cost in indirect material, indirect labor, and indirect expenses. It also includes amount or units of WIP or
incomplete units at the end of the period.
Cost of Production: When Office and administration cost at the end of the period are added to the Factory cost, we
arrive at the cost of production or cost of goods sold. Here, we make an adjustment for opening and Closing finished
goods.
Total Cost: Total cost or alternatively cost of sales is the cost of production plus selling and distribution overheads.
Methods of Costing
Every business and organization has different nature and characteristics. So it also needs to employ different costing
systems to ascertain the cost of their products. So let us look at some of the most common and popular methods of
costing.

Methods of Costing

1] Job Costing
Many firms and businesses work on a job work basis. In such cases, we use the job costing method. Here the cost is
assigned to a specific job, assignment etc.
There is no pre-production here, each order is made to the specifications needed. If the system is implemented
accurately we can find the profitability of each job. Some important features of job costing are,

 It concerns itself with specific order costing, i.e the cost of each order or job regardless of the time taken to
finish the job. But usually, the duration of each job is relatively short.
 The costs are collected at the completion of the job
 Prime costs are traced and overheads are assigned to each job on some appropriate proportionate basis.

2] Batch Coting
Batch costing is used when the goods are not produced to demand but are pre-produced. Here the production process
is continuous and occurs in batches.
These batches may be for a specific order or some pre-determined quantity. In this system, the goods are more or
less uniform.
The total cost incurred during the production of one such batch of goods is divided by the number of units produced
to give us the cost per unit.
This method is very useful for consumer electronic goods such as televisions, washing machines etc.

3] Process Costing
This is one of the most popular methods of costing. There are many goods that are produced continuously.
These goods are homogeneous and are usually produced in huge quantities. So the method of process costing is used
to find the cost of production of each unit.
In continuous processing, the output of one process becomes the input of the next process and so on until we achieve
our finished product.
So for the purposes, we find out the costs of each process and divided it by the number of units produced in this
process. Some examples of products that use process costing are sugar, edible oil, chemicals, salt etc.
4] Operating Costing
Among all the methods of costing, the one best suited to the service sector is operating costing. We use operating
costs to calculate the cost of the services provided to the customers.
The service must be uniform service provided to all customers, not specialized services. And to ascertain the cost we
average the total cost over the total services rendered.

5] Contract Costing
To work out the cost of a contract undertaken we employ contract costing. So it will help us track the costs of a
specific contract with a specific customer.
These methods of costing are mainly used for construction contracts, like the construction of complexes, highways,
bridges, dams etc.
As you can see there are a lot of similarities between job costing and contract costing. But job costing is usually for a
shorter period.
While contract costing is for a much longer time, several years usually. So there is work-in-progress at the end of a
year in contract costing

Elements of Cost
The elements of cost are those elements which constitute the cost of manufacture of a product. We can broadly
divide these elements of cost into three categories. In a manufacturing organization, we convert raw materials into a
finished product with the help of labor and other services. These services are Material, Labour and Expenses.

Elements of Cost
Again, we can bifurcate these elements of cost into two categories such as Direct Material and Indirect
Material, Direct Labour and Indirect Labour, Direct Expenses and Indirect Expenses. We need to add all direct
material, direct labor, and direct expenses to calculate the prime cost.
Likewise, we add all indirect material, indirect labor, and indirect expenses to calculate the overhead cost. Again, we
can bifurcate the overheads into four categories. They are factory overhead, administrative overhead, selling
overhead and distribution overhead.

1. Direct Material
It represents the raw material or goods necessary to produce or manufacture a product. The cost of direct material
varies according to the level of output. For example, Milk is the direct material of ghee.

2. Indirect Material
It refers to the material which we require to produce a product but is not directly identifiable. It does not form a part
of a finished product. For example, the use of nails to make a table. The cost of indirect material does not vary in the
direct proportion of product.

3. Direct Labour
It refers to the amount which paid to the workers who are directly engaged in the production of goods. It varies
directly with the level of output.

4. Indirect Labour
It represents the amount paid to workers who are indirectly engaged in the production of goods. It does not vary
directly with the level of output.

5. Direct Expenses
It refers to the expenses that are specifically incurred by the enterprises to produce a product. The production cannot
take place without incurring these expenses. It varies directly with the level of production.
6. Indirect Expenses
It represents the expenses that are incurred by the organization to produce a product. These expenses cannot be
easily identified accurately. For example, Power expenses for the production of pens.

7. Overhead
It refers to all indirect materials, indirect labour, or and indirect expenses.

8. Factory Overhead
Factory overhead or Production Overhead or Works Overhead refers to the expenses which a firm incurs in the
production area or within factory premises.
Indirect material, rent, rates and taxes of factory, canteen expenses etc.are example of factory overhead.

9. Administration Overhead
Administrative or Office Overhead refers to the expenses which are incurred in connection with the general
administration of the organizations.
Salary of administrative staff, postage, telegram and telephone, stationery etc.are examples of administration
overhead.

10. Selling Overhead

All expenses that a firm incurs in connection with sales are selling overheads. Salary of sales department staff,
travelers’ commission, advertisement etc.are example of selling overhead.

11. Distribution Overhead

It represents all expenses incurred in connection with the delivery or distribution of finished goods and services from
the manufacturer to the consumer. F Delivery van expenses. loading and unloading, customs duty, the salary of
deliverymen are examples of distribution overhead.
Cost Control and Cost Reduction
Most of the enterprise is want to maximize the profit, which is possible by decreasing the production cost. For this
purpose, management uses two efficient tools, i.e. cost control and cost reduction. Cost Control is a technique which
makes available the necessary information to the management that actual costs are aligned with the budgeted costs
or not. Cost Reduction is a technique which we used to save the unit cost of the product without compromising
its quality.

Cost control and Cost reduction

Definition of Cost Control

Cost Control is a process in which we focus on controlling the total cost through competitive analysis. It is a practice
which works to align the actual cost in agreement with the established norms.
It ensures that the cost incurred on production should not go beyond the pre-determined cost. Cost Control involves
a chain of various activities, which starts with the preparation of the budget in relation to production.
Thereafter we evaluate the actual performance. After that we compute the variances between the actual cost & the
budgeted cost and further, we find out the reasons for the same. Finally, we implement the necessary actions for
correcting discrepancies.
The major techniques which used in cost control are standard costing and budgetary control. It is a continuous
process which helps in analyzing the causes for variances. For example- control wastage of material, any
embezzlement and so on.

It involves:

1. Determination of standards;
2. Ascertaining actual results comparing the standards;
 3. An analysis of the variances;
4. Establishing the action that may be taken.

Characteristics of a Good Cost Control System

According to backer and Jacobson, effective cost control should have the following characteristics :
(a) Delineation of centers responsibility, i.e., deciding responsibility centers;
(b) The delegation of prescribed authority;
(c) Various cost standards;
(d) The relevance of controllable cost;
(e) Cost reporting; and
(f) Cost reduction

Definition of Cost Reduction

Cost Reduction is a process, which aims to lower the unit cost of a product manufactured or service rendered
without affecting its quality. It can be done by using new and improved methods and techniques. It ascertains
substitute ways to reduce the production cost of a unit.
Thus, cost reduction ensures savings in per unit cost and maximization of profits of the enterprise. Cost Reduction
aims at cutting off the unnecessary expenses which occur during the production Process, storage, selling and
distribution of the product. To identify cost reduction we should focus on the following major elements:

 Savings in per unit production cost.

 The quality of the product should not be affected.
 Savings should be non-volatile in nature.
Tools of cost reduction focus on Quality operation and research, Improvement in product design, Job Evaluation &
merit rating, variety reduction, etc.

Difference Between Cost Control and Cost Reduction

The following are the main differences between Cost Control and Cost Reduction:

1. Cost Control focuses on decreasing the total cost of production while cost reduction focuses on decreasing
per unit cost of a product.
2. Cost Control is a temporary process in nature. Unlike Cost Reduction which is a permanent process.
3. The process of cost control will be completed when the specified target is achieved. Conversely, the process
of cost reduction is a continuous process. It has no visible end. It targets for eliminating wasteful expenses.
4. Cost Control does not guarantee quality maintenance of products. However, cost reduction assured 100%
quality maintenance.
5. Cost Control is a preventive function because it ascertains the cost before its occurrence. Cost Reduction is
a corrective function.

Advantages of Cost Accounting

Cost accounting has now become the norm in most industries and firms. Almost all medium and large scale
businesses rely on cost accounting to supplement the information that financial accounting provides. In fact, cost
accounting is essential not only to businessmen and the management but also to the economy as a whole. Let us take
a look at some of the advantages of cost accounting.
Advantages of Cost Accounting

1] Measuring and Improving Efficiency

Cost accounting allows for data that enables the firm to measure efficiency. This could be efficiencies with respect to
cost, time, expenses etc.
Standard costing is then used to compare actual numbers with the industry or economy standards to indicate changes
in efficiency.
Say for example the cost of producing one unit increased from Rs.100/- to Rs. 110/-. Now was this due to an
increase in prices or due to inefficiency and wastages. Cost accounting will help you measure this.

2] Identification of Unprofitable Activities

Just because a firm is making overall profits, it does not mean all activities are profitable. Cost accounting will help
us identify the profitable and unprofitable activities of the firm.
So activities that cause the firm losses can be made profitable or eliminated. This can happen due to the cost
ascertainment done in cost accounting.

3] Fixing Prices
This is one of the important advantages of cost accounting. Many businesses price their products based on the cost of
production of these products.
To enable this, we first need to calculate the actual cost of production of these products. Costing makes the
distinction between fixed cost and variable cost, which allows the firm to fix prices in different economic scenarios.
Prices that we fix without the help of cost accounting can be too high or low, and both cause losses to the business.

4] Price Reduction
Sometimes during tough economic conditions, like depression, the prices have to be reduced. In some cases, these
prices are reduced to below the total cost of the product.
This is to help the company survive this tough period. Such decisions the management has to take are guided by cost
accounting.

5] Control over Stock

Another important advantage of cost accounting is that it helps with restocking and control over materials. Cost
accounting will help us calculate the most ideal and economic re-order level and quantities.
This will ensure that the firm is never overstocked or understocked. Also costing allows the management to keep a
check over these raw materials, WIP etc.

6] Evaluates the Reasons for Losses

Every firm has to deal with periods of profits and losses. But now they must always evaluate or investigate the
reasons for the losses suffered.
This will help to tackle the problem or overcome the cause by some other means necessary. So if you cannot
eliminate the reason you can at least minimize the losses.
Cost accounting plays a huge role in determining the cause of any losses. Say, for example, your cost of production
is low, and prices are high but yet losses persist. This can be due to low output levels due to inefficiency. Cost
accounting helps us determine this.

7] Aids Future Planning

One of the biggest advantages of cost accounting is that it will help the management with future plans they may
have. For any production or selling plans, it is important to have detailed data about the machines, the labour
capacity, output levels, levels of efficiency of each process etc.
Say for example the management wishes to expand the production to accommodate sales, cost accounting will help
determine if the current machines can handle these levels of production or not.
Techniques of Costing
The purpose of cost accounting is to compute the total cost of the production of goods or the cost of providing
services. But the presentation of this cost data depends on the techniques of costing employed. These various
techniques of costing also help in cost control and cost reduction. Let us take a look.

Techniques of Costing

1] Marginal Costing
Marginal costing is based on the principle of dividing all costs into fixed cost and variable cost.
Fixed costs are unrelated to the levels of production. As the name suggests these costs remain the same irrespective
of the production quantities.
Variable costs change in relation to production levels. They are directly proportionate. The variable cost per unit,
however, remains the same.
And in marginal costing, we only consider these variable costs while calculating the production costs.
Of all the available techniques of costing, marginal costing is most suitable for making decisions like how much
material to buy, the correct product mix, fixing the selling price etc.

2] Standard Costing
Standard costing is a technique where the firm compares the costs that were incurred for the production of the goods
and the costs that should have been incurred for the same.
Essentially it is the comparison between actual costs and standard costs. The differences between the two are
variances.
The standards costs we use for this comparison are pre-determined. Such standard costs of materials, labor,
overheads are calculated with scientific and technical analysis. They help set the benchmark for the whole industry.
If the actual costs are greater than these standard costs, the variance is adverse. So we analyze the reason for this
adverse variance and try and solve the root causes.
And if the standard costs are higher than the actual costs, the variance is favorable. Even favorable variances must be
analyzed.

3] Budget and Budgetary Control

When we talk about the techniques of costing, budgetary control is an important technique. A budget is a
quantitative statement prepared prior to the defined period in order to help achieve certain objectives of the firm.
This budget can be in the form of quantities or can be a monetary statement.
For example, a production budget will deal in quantities of goods to be produced. On the other hand, a marketing
budget will be a monetary statement.
Another important feature of a budget is that it is prepared ahead of time. So the budget can be for the next quarter or
the next year or any such predetermined period.
A budget will lay down the objectives of this period, and the firm’s methods to achieve them.
Budgetary control is the preparation of budgets and analysis of the actual performance of the firm in comparison to
the budgeted numbers.
If there is a lot of variation from the budget the firm can take corrective action. This is how budgetary control works.
Food costing is important to know as it has a direct effect on the profitability of a restaurant. It is the cost of
your ingredients and does not include other costs, such as labour and overheads. Food costing is an essential
tool in determining whether food costs targets are being met.

What is Food Cost?

Food cost determines a restaurant’s profitability. It is what a plate is being sold for on a menu verses what it
costs to prepare the plate. Most businesses want their food cost to be at or below 30%.

Why Should I know my Food Cost?

A restaurant’s food cost determines its profitability. Without knowing what the food cost is, there is no way to
know if the items on a menu is generating a profit? For example: lets say a menu item is a “slice of apple pie”.
In order for the restaurant to meet their 30% food cost goal they would need to know what that slice of pie costs
to produce. That slice of pie costs $1.00 to make, so it needs to be sold for at least $4.50 to meet a 30% food
cost goal. A restaurant’s food cost covers everything that goes into running the business, from payroll to rent so
it is imperative that all menu items meet that threshold.

How do I maintain a low food cost?

To maintain a low food cost a restaurant needs be take be acutely aware of how much inventory they have and
how they are using it. According to a Green Restaurant Association analysis “a single restaurant in the U.S. can
produce approximately 25,000-75,000 pounds of food waste in a year depending on the size of the
establishment”. That is money thrown away.

Unilever Food Solutions’ World Menu Report, Sustainable Kitchens: Reducing Food Waste, noted that
reducing food waste provides financial benefits for operators, including a reduction in disposal costs and
increased kitchen efficiency. In addition, nearly half of those surveyed in the U.S. say they would spend more
for meals at restaurants and food service locations that are taking steps to limit food waste. With 49 percent of
American’s food budget being spent in the restaurant community operators and chefs would be wise to take
steps to reduce food waste in order attract customers as well as reduce their bottom line.

1. Keep track of your products

It is impossible to run an efficient kitchen if you do not know how much product you have to work with. How
much do you have? Are you out of something? Is inventory disappearing? Without keeping track of your
products you will be unable to answer these questions and chances are you are loosing money. To avoid this,
take stock of your inventory and do it often. The more you know what you have to work with, the less likely you
and your staff will be to waste the products that you have.

2.Practice the “Root to Stem” technique

A growing trend in restaurants is the “root to stem” technique of cooking. The high cost of food combined with
the growing interest in being “green” has helped “root to stem” cooking grown in popularity. Everyone from the
home cook to the restaurant chef is looking for ways to stretch their food dollar and this new way of cooking is
all about using every viable resource of a product.

3. Composting

Today, many restaurants are keeping a garden to provide them with fresh produce on a daily basis. There is no
better way to maintain a garden than by fertilizing it, and you can turn your food scraps into nutritious food for
your garden by composting. Check out Sustainable Foodservice.com to learn about all the different techniques
you can use to turn your leftovers into fertilizer.

4. Spend time planning your week.

In order to keep food waste at a minimum it is imperative to plan. By ordering the right amount of product for a
set number of dinner services you will be less inclined to waste. Calculate the amount of money you spend on
each of your recipes so you can rest easy knowing your dollars are wisely spent and not feeding the trash bin.

5. Consider a creative reconstruction of your menu.

During uncertain economic periods it is imperative that restaurants change with the times. Instead of raising
your prices to compensate for that expensive cut of meat, try reworking the recipe to use a less expensive cut, or
substitute more produce into the dish. Another great way to save is to incorporate local seasonal produce into
 your dishes instead of importing expensive out of season fruits and vegetables. Not only will you be satisfying
your customer by not raising prices, but your till will be full as well.

With some creative thinking and a little planning it is possible to come up with many solutions to the rising cost
of food. By investing in the right tools, planning out your menus, and reworking your dishes it is possible to
keep prices down and customers happy.

How do I figure out my food cost?

There are many tools on the market to help calculate food costs.

For example, MenuMax will match the ingredients in your recipes to the items in your order guides and
calculate the food cost for that dish, down to the last cent. Knowing the exact cost of an item will let you
analyze the inflation cost, set a price that meets margins and satisfies customers.

Over the last year 9,450 restaurants in the U.S. closed. Nearly 92% were independents that did not manage their
food costs wisely.

MenuMax arms you with the tools and knowledge you need to engineer a highly

profitable menu. With MenuMax you can manage your profit margins by viewing total recipe cost, single-
serving cost, and menu food cost percentage for a higher return on investments.

INGREDIENT COSTING
The Importance of Counting Costs

Food costing is important to know as it has a direct effect on the profitability of a restaurant. It is the cost of
your ingredients and does not include other costs, such as labour and overheads. Food costing is an essential tool
in determining whether food costs targets are being met.
On Basic Recipe Costing

Understanding the basics of recipe costing is important so that you can:

 Know how much food cost is incurred on each recipe. This gives you a clear view of how much you can earn
per dish.
 Understand how to properly price your dishes to achieve a target profit.
 Study the way your competitor price their dishes against an industry benchmark.
 Know when to reduce a recipe cost. If you keep up-to-date with your costing, and see that you are going beyond
your target cost percentage, you can easily plan how to reduce the costs.
 Find out each menu item’s profit margin and decide which ones to promote through suggestive selling and
promotions.
Food Costing Tools

The following tools and calculations are important in deriving your food costs:

 Standard Recipe: Costing based on a standard recipe makes it easy to compute food costs based on the
servings that are needed
 Up-to-Date Ingredient Costs: Current prices should be the basis of costing, thus the need to do a price check
from time to time
 Recipe Cost Sheet: For recording data and all information about the recipe such as current unit cost, actual
ingredient cost and cost per portion

Calculating Recipe Cost

How do we apply numbers and costs to each Standard Recipe?

 Step 1. Fill up the Recipe Costing Sheet with information based on the standard recipe to be based on a current
price list.
 Step 2. Indicate the latest purchase cost of each ingredient based on a current price list.
 Step 3. Compute the actual cost of each ingredient
 Step 4. Add actual cost of each ingredient to get the total recipe cost
 Step 5. Divide the total recipe cost by number of portions to get the cost per portion

Recipe Cost Sheet

For recording purposes, create a recipe cost sheet for each of your dishes. Here is an example.

As you can see, it’s an extension of the Standard Recipe, providing costing details.

Selling Price

Once you have your food costs, you can figure out the selling price of your dishes. The basic formula is:

Selling Price = (Food Cost + Labour Cost + Overhead Cost) + Profit

Your selling price should include all costs plus the profit you would like to earn.

What Should the Food Cost Percentage of Your Selling Price Be?

To compute the selling price, we need the food cost to only be a certain percentage of the selling price.

The amount varies from one restaurant section to another, and is influenced by other costs, such as labour,
overhead, and target profit. It generally falls within the profit of 30 to 45%.

Module 3 BUDGETING

A budget is a financial plan for a defined period, often one year. It may also include planned sales volumes
and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. Companies,
governments, families and other organizations use it to express strategic plans of activities or events in
measurable terms.
Budgeting is the process of creating a plan to spend your money. This spending plan is called a budget.
Creating this spending plan allows you to determine in advance whether you will have enough money to do the
things you need to do or would like to do.

Why is Budgeting so Important?

Since budgeting allows you to create a spending plan for your money, it ensures that you will always have
enough money for the things you need and the things that are important to you. Following a budget or
spending plan will also keep you out of debt or help you work your way out of debt if you are currently in debt.

What about Budget Forecasting and Planning?

Once you create your first budget, begin to use it and get a good feel for how it can keep your finances on
track, you may want to map out your spending plan or budget for 6 months to a year down the road. By doing
this you can easily forecast which months your finances may be tight and which ones you'll have extra money.
You can then look for ways to even out the highs and lows in your finances so that things can be more
manageable and pleasant.
Extending your budget out into the future also allows you to forecast how much money you will be able to save
for important things like your vacation, a new vehicle, your first home or home renovations, an emergency
savings account or your retirement. Using a realistic budget to forecast your spending for the year can really
help you with your long term financial planning. You can then make realistic assumptions about your annual
income and expense and plan for long term financial goals like starting your own business, buying an
investment or recreation property or retiring.

MODULE 4 MATERIALS CONTROL:

What is Purchase Order?

A purchase order, or PO, is an official document issued by a buyer committing to pay the seller for the sale of
specific products or services to be delivered in the future.
The advantage to the buyer is the ability to place an order without immediate payment. From the seller’s
perspective, a PO is a way to offer buyers credit without risk, since the buyer is obligated to pay once the
products or services have been delivered.
Each PO has a unique number associated with it that helps both buyer and seller track delivery and payment. A
blanket PO is a commitment to buy products or services on an ongoing basis, until a certain maximum is
reached.

What is on a Purchase Order?

Among other things, a PO specifies:

  Quantity purchased
 Product or service being purchased
 Specific brand names, SKUs, or model numbers
 Price per unit
 Delivery date
 Delivery location
 Billing address
 Payment terms, such as on delivery or in 30 days

How is a Purchase Order Used?

A PO simplifies the purchase process, which typically looks like this:

 Buyer decides to purchase a product or service for their business

 The company issues a PO to the seller, often electronically using a purchase order template
 The seller receives the PO and confirms the company can fill the order
 If not, the seller tells the buyer the order cannot be completed and the PO is cancelled
 If the order can be filled, the seller begins preparing the order by pulling the inventory together or scheduling
necessary personnel
 The order is shipped, or service provided, with the PO number on the packing list so the buyer knows which
order has arrived
 The seller invoices for the order, using the PO number so that it can easily be matched with the delivery
information
 The buyer pays the invoice according to the terms laid out in the PO

Purchase Order Pros and Cons

There are many reasons to use POs, the most important of which are:

 Improved accuracy, in both inventory and financial management

 Better budgeting, since funds need to be available before a PO is issued
 Faster delivery, since POs help schedule delivery when the buyer needs it
As far as disadvantages go, there are few:

 More unnecessary paperwork for smaller purchases

 Credit cards can serve the same purpose from a financial perspective

Stores Requisition
A stores requisition is a form that a user fills out when removing parts from storage. The form is used by
the organization's cost accounting system to charge the cost of the parts to a job. The information to be
added to the form includes the following:

 Removal date
 Job number to be charged
 Part number and description
 Number of units removed
 Approval signature

A stores requisition is used in a manual materials handling process. In a computeri zed system, a screen
takes the place of the form.

STORES LEDGER- LIFO

Last-in, first-out (LIFO) method in a perpetual inventory system

In contrast to first-in, first-out (FIFO) method, the last-in, first-out (LIFO) method of inventory valuation
assumes that the last costs incurred to purchase merchandise or direct materials are first costs charged against
revenues. In other words, it assumes that the cost of merchandise sold (in a merchandising company) or the cost
of materials issued to production department (in a manufacturing company) is the cost of most recent purchases.
Like first-in, first-out (FIFO), last-in, first-out (LIFO) method can be used in both perpetual inventory system
and periodic inventory system. The following example explains the use of LIFO method for computing cost of
goods sold and the cost of ending inventory in a perpetual inventory system.

Example – LIFO perpetual inventory system in a merchandising company:

BZU uses perpetual inventory system to record purchases and sales and LIFO method to valuate its inventories.
The company has provided the following information about commodity DX-13C and wants your assistance in
computing the cost of commodity DX-13C sold and the cost of ending inventory of commodity DX-13C.

 Aug. 01: Beginning inventory; 20 units @ $40 per unit.

 Aug. 07: Sales; 14 units.
 Aug. 12: Purchases; 16 units @ $42 per unit.
 Aug. 17: Sales; 8 units.
 Aug. 23: Sales; 4 units.
 Aug. 27: Purchases; 8 units @ $44 per unit.
 Aug. 30: Sales; 10 units.

Required:

1. Prepare a LIFO perpetual inventory card.

2. Compute cost of goods sold and the cost of ending inventory using LIFO method.

Solution:

(1). LIFO perpetual inventory card:

(2). Cost of goods sold (COGS) and ending inventory:

LIFO perpetual inventory card (prepared above) can help compute cost of goods sold and ending inventory.

a. Cost of goods sold (COGS): $560 + $336 + $168 + $436 = $1,500

b. Ending inventory: [$240 + $84] = $324

When LIFO method is used in a perpetual inventory system, it is typically known as “LIFO perpetual system”.

The Three Star company manufactures product X. Material K5 is used to manufacture product X. The
information about the acquisition and issuance of material K5 for the month of June is given below:

 Jun. 01: Beginning inventory; 50 kgs @ $4.80/kg and 100 kg @ $5.00/kg.

 Jun. 05: 10 kgs of material K5 were returned to supplier.
 Jun. 09: 35 kgs of material K5 were issued to factory.
 Jun. 12: 70 kgs of material K5 were purchased @ $5.10/kg.
 Jun. 17: 50 kgs of material K5 were issued to factory.
 Jun. 19: 25 kgs of material K5 were issued to factory.
 Jun. 23: 50 kgs of material K5 were purchased @ $5.20/kg
 Jun. 26: 60 kgs of material K5 were issued to factory.
 Jun. 30: 5 kgs of material K5 were returned from factory to store room.
A perpetual inventory system is used to account for acquisition and issuance of direct materials.

Required: Compute the cost of material K5 issued to factory and the cost of material K5 at the end of June
using last-in, first-out (LIFO) method.

Solution:

As the company uses perpetual inventory system, a materials ledger card would be prepared to compute the cost
of materials issued to factory and the cost of materials on hand at the end of the month. Materials ledger card is
similar to inventory card prepared above. Materials ledger card of Three Star company is give below:

(1). LIFO perpetual material card:

* Materials returned from store room to supplier is usually recorded in purchases column and materials returned
from factory to store room is usually written in issues column. The returns are normally written in red ink to
differentiate them from normal purchases and issues.

(2). Cost of material issued to factory:

= $175 + $255 + $102 + $25 + $260 + $50 – $25*

= $842

*Material returned from factory to store room

(3). Cost of inventory on hand on June 30th:

= $240 + $225

= $465

What Is First In, First Out (FIFO)?

First In, First Out, commonly known as FIFO, is an asset-management and valuation method in which assets
produced or acquired first are sold, used, or disposed of first. For tax purposes, FIFO assumes that assets with
the oldest costs are included in the income statement's cost of goods sold (COGS). The remaining inventory
assets are matched to the assets that are most recently purchased or produced.

How First In, First Out (FIFO) Works

The FIFO method is used for cost flow assumption purposes. In manufacturing, as items progress to
later development stages and as finished inventory items are sold, the associated costs with that product must be
recognized as an expense. Under FIFO, it is assumed that the cost of inventory purchased first will be
recognized first. The dollar value of total inventory decreases in this process because inventory has been
removed from the company’s ownership. The costs associated with the inventory may be calculated in several
ways — one being the FIFO method.

FIFO vs. Other Valuation Methods

LIFO
The inventory valuation method opposite to FIFO is LIFO, where the last item purchased or acquired is the first
item out. In inflationary economies, this results in deflated net income costs and lower ending balances in
inventory when compared to FIFO.

Average Cost Inventory

The average cost inventory method assigns the same cost to each item. The average cost method is calculated by
dividing the cost of goods in inventory by the total number of items available for sale. This results in net income
and ending inventory balances between FIFO and LIFO.

Specific Inventory Tracing

Finally, specific inventory tracing is used when all components attributable to a finished product are known. If
all pieces are not known, the use of any method out of FIFO, LIFO, or average cost is appropriate.
 Module 5 : Menu Costing:

What are Menu Costs?

Menu costs refer to an economic term used to describe the cost incurred by firms in order to change their prices.
How expensive it is to change prices depends on the type of firm. For example, it may be necessary to reprint
menus, update price lists, contact a distribution and sales network or manually re-tag merchandise on the shelf.
Even when there are few apparent menu costs, changing prices may make customers apprehensive about buying
at the new price. This purchasing hesitancy can result in a subtle type of menu cost in terms of lost potential
sales.

Understanding Menu Costs

The main takeaway from menu costs is that prices are sticky. That is to say, firms are hesitant to change their
prices until there is a sufficient disparity between the firm's current price and the equilibrium market price. In
theory, a firm should not change its price until the price change will result in enough additional revenues to
cover the menu costs. In practice, however, it may be difficult to determine the equilibrium market price or to
account for all menu costs, so it is hard for firms and consumers to behave precisely in this manner.

The concept of menu costs was originally introduced by Eytan Sheshinski and Yoram Weiss in 1977. The idea
of applying it as a general theory of nominal price rigidity was simultaneously put forward by several New
Keynesian economists from 1985 to 1986. George Akerlof and Janet Yellen, for example, put forward the idea
that, due to bounded rationality, firms will not want to change their price unless the benefit is more than a small
amount. This bounded rationality leads to inertia in nominal prices and wages, which can lead to output
fluctuating at constant nominal prices and wages.

Hubbart Formula:
Hubbart Formula is a bottom-up approach to pricing rooms introduced by Roy Hubbart in 1940. This approach
considers operating costs, desired profits, and expected number of rooms sold to determine the average rate per
room. It is considered a bottom-up approach because its initial item – net income (profit) – appears at the bottom
of the income statement.
As hotels see a constant increase in competition, they are forced to try and compete with other big name
companies by providing better quality rooms or lower prices. In order to offer these lower prices, the Hubbart
Formula is often used to deduce these prices.
Advantages of Hubbart Formula
1. Systematic method of determining optimal average room rate.
2. Forecast the desired return for any period of time.
3. It takes into account the revenue accrued from non-room departments.
4. Allows the manager to price in things like non-operating expenses.
CALCULATING ROOM RATES USING THE HUBBART FORMULA
 Calculate desired profit:
Desired Profit = Owner’s Investment X ROI
 Calculate pre-tax profits:
Pretax Profit= Net Income / 1 – Tax Rate

 Calculate fixed charges and management fees:

Depreciation+ Interest Expense Property Taxes Insurance+ Building Mortgage+ Land+ Rent+ Management
Fees
 Calculate undistributed operating expenses:
 Administrative + Information technology Human resources + Transportation + Marketing + Property +
Operation + maintenance + energy costs
 Estimate non-room operated department profit / loss :
Food & Beverage Costs and Income+ Telephone Income
 Calculate required rooms department income:
The sum of pretax profits (Step 2), fixed charges and management fees (Step 3), undistributed operating
expenses (Step 4), and other operated department income (Step 5) equals the required rooms department
income.
 Determine rooms department revenue
Required rooms department income + rooms department direct expenses of payroll and related expenses + other
direct operating expenses

 Calculate average daily rate (ADR)

Divide Rooms Department Revenue by the Expected Rooms Sold to calculate ADR.

MODULE 6: BREAK EVEN ANALYSIS

What is a Break-Even Analysis?

A break-even analysis is a financial tool which helps you to determine at what stage your company, or a new
service or a product, will be profitable. In other words, it’s a financial calculation for determining the number of
products or services a company should sell to cover its costs (particularly fixed costs). Break-even is a situation
where you are neither making money nor losing money, but all your costs have been covered.
Break-even analysis is useful in studying the relation between the variable cost, fixed cost and revenue.
Generally, a company with low fixed costs will have a low break-even point of sale. For an example, a company
has a fixed cost of Rs.0 (zero) will automatically have broken even upon the first sale of its product.

Components of Break Even Analysis

Fixed costs
Fixed costs are also called as the overhead cost. These overhead costs occur after the decision to start an
economic activity is taken and these costs are directly related to the level of production, but not the quantity of
production. Fixed costs include (but are not limited to) interest, taxes, salaries, rent, depreciation costs, labour
costs, energy costs etc. These costs are fixed no matter how much you sell.
Variable costs
Variable costs are costs that will increase or decrease in direct relation to the production volume. These cost
include cost of raw material, packaging cost, fuel and other costs that are directly related to the production.

When is Break even analysis used?

Starting a new business: If you wish to start a new business, a break-even analysis is a must. Not only it helps
you in deciding, whether the idea of starting a new is viable, but it will force you to be realistic about the costs,
as well as guide you about the pricing strategy.
Creating a new product: In the case of an existing business, you should still do a break-even analysis before
launching a new product—particularly if such a product is going to add a significant expenditure.
Changing the business model: If you are about to the change your business model, like, switching from
wholesale business to retail business, you should do a break-even analysis. The costs could change considerably
and this will help you to figure out the selling prices need to change too.

Breakeven analysis is useful for the following reasons:

 It helps to determine remaining/unused capacity of the concern once the breakeven is reached. This
will help to show the maximum profit on a particular product/service that can be generated.
 It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces
a variable cost).
 It helps to determine the change in profits if the price of a product is altered.
  It helps to determine the amount of losses that could be sustained if there is a sales downturn.

Additionally, break-even analysis is very useful for knowing the overall ability of a business to generate a profit.
In the case of a company whose breakeven point is near to the maximum sales level, this signifies that it is
nearly impractical for the business to earn a profit even under the best of circumstances.
Therefore, it’s the management responsibility to monitor the breakeven point constantly. This monitoring
certainly reduces the breakeven point whenever possible.

Ways to monitor Break even point

 Pricing analysis: Minimize or eliminate the use of coupons or other price reductions offers, since such
promotional strategies increase the breakeven point.
 Technology analysis: Implementing any technology that can enhance the business efficiency, thus
increasing capacity with no extra cost.
 Cost analysis: Reviewing all fixed costs constantly to verify if any can be eliminated can surely help.
Also, review the total variable costs to see if they can be eliminated. This analysis will increase the
margin and reduce the breakeven point.
 Margin analysis: Push sales of the highest-margin (high contribution earning) items and pay close
attention to product margins, thus reducing the breakeven point.
 Outsourcing: If an activity consists of a fixed cost, try to outsource such activity (whenever possible),
which reduces the breakeven point.

Benefits of Break-even analysis

Catch missing expenses: When you’re thinking about a new business, it’s very much possible that you may
forget about few expenses. Therefore, if you do a break-even analysis you have to review all your financial
commitments to figure out your break-even point. This analysis certainly restricts the number of surprises down
the road.
Set revenue targets: Once the break-even analysis is complete, you will get to know how much you need to
sell to be profitable. This will help you and your sales team to set more concrete sales goals.
Make smarter decisions: Entrepreneurs often take decisions in relation to their business based on emotion.
Emotion is important i.e. how you feel, though it’s not enough. In order to be a successful entrepreneur, your
decisions should be based on facts.
Fund your business: This analysis is a key component in any business plan. It’s generally a requirement if
you want outsiders to fund your business. In order to fund your business, you have to prove that your plan is
viable. Furthermore, if the analysis looks good, you will be comfortable enough to take the burden of various
ways of financing.
Better Pricing: Finding the break-even point will help in pricing the products better. This tool is highly used
for providing the best price of a product that can fetch maximum profit without increasing the existing price.
Cover fixed costs: Doing a break-even analysis helps in covering all fixed cost.

What Is Cost-Volume-Profit – CVP Analysis?

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of
costs and volume have on operating profit. The cost-volume-profit analysis, also commonly known as break-
even analysis, looks to determine the break-even point for different sales volumes and cost structures, which can
be useful for managers making short-term economic decisions.

The cost-volume-profit analysis makes several assumptions, including that the sales price, fixed costs, and
variable cost per unit are constant. Running this analysis involves using several equations for price, cost and
other variables, then plotting them out on an economic graph.

Cost–volume–profit (CVP), in managerial economics, is a form of cost accounting. It is a simplified model,

useful for elementary instruction and for short-run decisions.
A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs).
At this break-even point, a company will experience no income or loss. This break-even point can be an initial
examination that precedes more detailed CVP analysis.
CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP
analysis are:

 The behavior of both costs and revenues are linear throughout the relevant range of activity. (This
assumption precludes the concept of volume discounts on either purchased materials or sales.)
 Costs can be classified accurately as either fixed or variable.
 Changes in activity are the only factors that affect costs.
 All units produced are sold (there is no ending finished goods inventory).
 When a company sells more than one type of product, the product mix (the ratio of each product to total
sales) will remain constant.
The components of CVP analysis are:

 Level or volume of activity.

 Unit selling prices
 Variable cost per unit
 Total fixed costs
 Manpower Cost Direct and indirect

CVP assumes the following:

 Constant sales price;

 Constant variable cost per unit;
 Constant total fixed cost;
 Units sold equal units produced.
These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary
discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and
the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful.
One of the main methods of calculating CVP is profit–volume ratio which is (contribution /sales)*100 = this
gives us profit–volume ratio.

 Contribution stands for sales minus variable costs.

Therefore, it gives us the profit added per unit of variable costs.

Applications
CVP simplifies the computation of breakeven in break-even analysis, and more generally allows simple
computation of target income sales. It simplifies analysis of short run trade-offs in operational decisions.
Limitations
CVP is a short run, marginal analysis: it assumes that unit variable costs and unit revenues are constant, which
is appropriate for small deviations from current production and sales, and assumes a neat division between fixed
costs and variable costs, though in the long run all costs are variable. For longer-term analysis that considers the
entire life-cycle of a product, one therefore often prefers activity-based costing or throughput accounting.[1]
When we analyze CVP is where we demonstrate the neither point at which in a firm there will be no profit nor
loss means that firm works in breakeven situation
1. Segregation of total costs into its fixed and variable components is always a daunting task to do.
2. Fixed costs are unlikely to stay constant as output increases beyond a certain range of activity. 3. The analysis
is restricted to the relevant range specified and beyond that the results can become unreliable.
4. Aside from volume, other elements like inflation, efficiency, capacity and technology impact on costs
5. Impractical to assume sales mix remain constant since this depends on the changing demand levels.
6. The assumption of linear property of total cost and total revenue relies on the assumption that unit variable
cost and selling price are always constant. In real life it is valid within relevant range or period and likely to
change.