Costeo Op1

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Operaciones Hoteleras
The Elements of Cost

Materials = Direct Materials + Indirect Materials
+ + +
Labour = Direct labour + Indirect Labour
+ + +
Overheads = Direct Overheads + Indirect Overheads
= = =
Total Cost = Total Direct Cost + Total Indirect Cost

Overheads
Fuel costs
Administration costs
Property costs
Selling costs
Communication costs
Maintenance costs

Behaviour of Costs
1. Variable Costs
2. Fixed costs
3. Mixed costs

Examples of different costs
Variable Fixed Mixed

The graphs below represent the behaviour of different costs; identify which graph represents which
cost behaviour?

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Question 1. Division of costs into Fixed & Variable.
The High Low Method
Month %Occupancy Cost of Gas $
Jan 20 250
Feb 25 275
March 40 370
April 50 385
May 60 450
June 70 515
July 80 550
August 75 510

Calculation of Variable Element
%Occupancy Cost of Gas
High point-July
Low point- Jan
Difference
Thus:
The variable element is:

The Fixed Element:

Jan: Variable cost =
Fixed cost =

July: Variable cost =
Fixed cost =

Question 2.
The following figures relate to a company that manufacture many items.
Sales Costs
Jan June 2003 3,900,000 3,480,000
July Dec 2003 4,300,000 3,760,000
Using the High Low method, calculate the fixed & variable costs.

Question 3
A motel has two different sales levels as follows
Monthly Room Sales
2,000 3,000
Payroll: $ $
Salaries 15,000 15,000
Wages 40,000 60,000
Employee benefits 9,200 10,700
Supplies 2,000 3,000
Utilities 8,000 9,000
Other costs 4,000 5,000
Rent 8,000 8,000
Interest 2,000 2,000
Insurance 3,000 3,000

a) Identify each cost as fixed, variable or mixed.
b) What are the total estimated costs per room sold?
c) What are the total estimated monthly fixed costs?
d) Develop an equation to estimate total costs at various levels of activity
e) Project the total costs if 3,500 rooms were sold

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Question 3.
A Pizza bar has the following costs at various levels of weekly sales:
Weekly sales in units 1,000 2,000
Materials $ 6,000 $ 12,000
Payroll costs 1,300 1,800
Lease 600 1,000
Supplies 600 1,200
Depreciation 500 500
Utilities 400 600
Other operating costs 300 600
Total 10,700 18,700

a) Identify the mixed costs.
b) Identify the variable costs
c) Identify the fixed costs
d) Develop an equation to estimate costs at various levels of activity.
e) Project total costs with weekly sales of 3,400 units.

Fixed versus Variable Costs
Many goods and services may be offered on either a fixed or a variable cost arrangement. A good
example is a lease. Managements decision to select the fixed or variable lease will be based on cost
benefit considerations.

With the fixed lease, the cost will remain the same, no matter the level of activity. Under a variable
lease, the cost is directly dependent upon the level of activity.

The level of activity at which the fixed lease cost = the variable lease cost is known as the indifference
point.

For example: Assume that a food service operation has an option of signing either an annual fixed
lease of $48,000 or a variable lease set at 5% of revenue. The indifference point is calculated as
follows:

The indifference point is where: Variable cost % x Revenue = Fixed Lease Cost

0.05(Revenue) = $48,000; Revenue = $48,000; Revenue = $960,000
0.05

Thus where the annual revenue is exactly $960,000, the lease expense will be $48,000, regardless of
whether the lease arrangement is fixed or variable.

Therefore if annual revenue is expected to exceed $960,000, then management should select a fixed
lease in order to minimise its lease expense.

However, if annual revenue is expected to be less than $960,000, a variable lease will minimise its
lease expense.

Question 2.
The Star Motel wishes to lease a building for food service. Two lease options are available:
(i) Variable lease at 8% of sales
(ii) Mixed lease at $1,000 per month plus 4% of sales

a) What is the indifference point?
b) Assuming the average monthly sales are expected to be $20,000, calculate the cost of each lease
option
c) Based on your calculations in part (b), which option would you recommend?
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Question 4
Doug Little is interested in renting space for a F & B business, he has the following 3 alternatives:
a) $2,000 fixed rent per month
b) $1,000 fixed rent per month plus 2% of sales
c) $1,500 fixed rent per month plus 4% of monthly sales in excess of $37,500
Required:
1. Determine the indifference point
2. Calculate the total lease cost for each alternative if monthly sales are expected to
be $80,000, and state which alternative you recommend.

Direct and Indirect Costs
Departments in a hospitality operation can be divided into two types:
1. Profit Centres/Operated Departments.
2. Support/Service Departments

Both have their own direct costs. These are costs that can be directly traced to a service department
or profit centre.

The direct costs of support/service departments are regarded as overheads of the hospitality
operation, and will eventually be allocated to the profit centres. Thus the direct cost of the service
department is the indirect cost of the profit centre

Profit Centres/Operated Departments
Rooms Department: Restaurant: Bar: Banqueting: Gift Shop:

Support/Service Departments
Maintenance: Laundry: Stores: Marketing:

Overheads
Overhead costs include all costs other than direct costs incurred by profit centres. Thus, overhead
costs are indirect costs of profit centres.

Overhead costs include the direct costs of service departments plus undistributed operating
expenses, i.e. Administrative & General; Human Resources; Information Systems; Security; Marketing;
Franchise Fees; transportation; Property Operation & Maintenance and Utility Costs.

It also covers fixed charges, i.e. Management Fees; Rent, Property Taxes & Insurance; Interest
Expense; Depreciation & Amortisation.

Allocation of Overheads
Hospitality operations may want to distribute overhead costs among profit centres in order to
calculate a departmental profit for each profit centre. This process is commonly called cost
allocation, and the income statement produced is referred to as a fully-allocated income
statement.

The overhead costs may be distributed using a single allocation base approach (SABA) or a multiple
allocation base approach (MABA).

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Question 5:
The following income statement is the unallocated income statement of the ZZ Motel for the month
st
ending 31 December 2011.

Rooms F&B Total
Revenue $60,000 $40,000 $100,000
Cost of Sales 0 16,000 16,000
Payroll & Related Expenses 14,000 11,000 25,000
Other Direct Expenses 6,000 4,500 10,500
Total Expenses 20,000 31,500 51,500
Departmental Income 40,000 8,500 48,500

Undistributed Operating Expenses
Administrative & General 12,000
Marketing 3,000
Property operation & Maintenance 2,000
Utility Costs 4,000
Income before fixed charges 27,500
Fixed charges:
Insurance 3,000
Depreciation 18,000

Income before Tax 6,500
Tax 2,000
Net Income 4,500

Prepare a fully-allocated income statement using the SABA. All costs except Income Tax will be
allocated using square metres. The areas of the operated departments are as follows: Rooms 40,000
square metres; F&B 24,000 square metres

st
The Allocated Income Statement: ZZ Motel for month ending December 31 20X7
Rooms F&B Total
Overhead Costs:
Admin & General 12,000
Marketing 3,000
Property Operation & Maintenance 2,000
Utility Costs 4,000
Insurance 3,000
Depreciation 18,000
Total 42,000
Net Departmental Income 6,500
Income Taxes XXXXXXXXX XXXXXXXXX 2,000
Net Income XXXXXXXXX XXXXXXXXX 4,500

Using the above information complete the following table using the MABA direct method:

Indirect Expenses Bases
Insurance Book value of fixed assets
Depreciation Square Metres
Property, Operation, & Maintenance Square Metres
Marketing Ratio to sales
Utility Square Metres
A & G Number of employees

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Department Book value of F.A. Square Metres Number of Employees
Rooms $900,000 32,000 12
F&B 300,000 18,000 18
A&G 50,000 2,500 4
Marketing 30,000 500 1
Property Ops etc. 220,000 2,000 1

st
The Allocated Income Statement: ZZ Motel for month ending December 31 2011
Rooms F&B Total
Overhead Costs:
Admin & General 12,000
Marketing 3,000
Property Operation & Maintenance 2,000
Utility Costs 4,000
Insurance 3,000
Depreciation 18,000
Total 42,000

After Cost Allocation
In both cases the F&B department shows a loss after cost allocation. Assuming the cost allocation was
reasonable, what should be done, if anything? Management should consider at least four factors
when deciding what to do about an underperforming department

1. The underperforming departments income. In our example management of the ZZ Motel might
propose closing the F&B department, however this would result in the lose of the departments
income of $8,500. Also assuming that the allocated overhead costs would be incurred anyway, the
F&B overhead would be re-allocated to the rooms department. The ZZ Motel would incur a $2,000
pre-tax loss by closing the F&B department as follows:
Net Departmental Income $6,500
Less: F&B Departmental income (8,500)
Net result (2,000)

2. The extent to which the overhead costs allocated to the underperforming department are fixed.
Will it be possible to avoid some of these costs, or will these costs still be incurred?

3. The extent to which the presence and performance of the department affects other profit centres.
If the F&B department is closed, sales in the rooms department might decrease, and this will also
impact on the pre-tax profit.

4. Operating alternatives for the underperforming department. This concerns the way in which the
F&B department is being managed. Alternative strategies may improve the departments
performance. Alternatives could include: a new marketing campaign, new menu, leasing the
restaurant to a restaurateur etc.

5. The validity of allocating the overheads. Is the method used fair and equitable? The bases used
need to be evaluated so as to ensure a valid result is obtained.

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The General Managers control over various costs

Controlled costs Non-controllable costs
Variable
F & B Lease (% of sales)
Room supplies Management fee (% of sales)
Wages Franchise fee (% of sales)
Undistributed Operating expenses

Fixed
Salaries Depreciation
Professional fees Property tax
Undistributed Operating expenses Interest
Subscriptions Rent
Maintenance fees Franchise fee
Insurance

The general manager and department managers should only be held accountable for the costs they
can control. To assess management performance the actual controllable costs incurred are compared
to the budgeted controllable costs, and any significant variance from the budget is investigated.

Question 6:
The XX Motel has 2 operated departments, Rooms and F&B, and 3 service departments Admin &
General, Marketing and Property Operation. The income statement is as follows:

The Income Statement of the XX Motel for the month of March 2011

Rooms F&B Total
Revenue $50,000 $50,000 $100,000
Cost of Sales 0 18,000 18,000
Payroll & Related Expenses 12,000 13,000 25,000
Other Direct Expenses 4,000 4,500 8,500
Total Expenses 16,000 33,500 51,500
Payroll
Undistributed Operating Expenses Related Other
Administrative & General 10,000 2,000 12,000
Marketing 2,000 1,000 3,000
Property operation, Maintenance &
Energy Costs 2,000 4,000 6,000
Income before fixed charges 27,500
Fixed charges:
Insurance 3,000
Depreciation 18,000

Tax 2,000
Net Income 4,500

Indirect expenses should be allocated using the following bases:

Indirect Expenses Bases
Depreciation Square footage
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Property, Operation, Maintenance & Energy Square footage
Marketing Ratio to sales
A & G Number of employees

Department Book value of F.A. Square footage Number of Employees
Rooms $900,000 40,000 14
F&B 300,000 15,000 20
A&G 50,000 2,500 4
Marketing 30,000 500 1
Property Ops etc 220,000 2,000 1

Using the above information complete the following table using the MABA direct method:

st
The Fully Allocated Income Statement: XX Motel for month ending March 31 2011

Rooms F&B Total
Overhead Costs:
A&G 12,000
Marketing 3,000
Property Ops, Maintenance & Energy 6,000
Insurance 3,000
Depreciation 18,000
Total 42,000

Other Costs.

Differential Costs.
In a decision-making situation, costs that differ between two alternatives are called differential costs.
These types of costs are important in the decision-making process. Costs that remain the same need
not be considered.

Relevant Costs.
Relevant costs are those that must be considered in a decision-making situation. In order for a cost to
be relevant, it must be differential, future, and quantifiable. The differential criterion demands that
the cost between two or more alternatives be different. The future characteristic demands that the
cost must not have already occurred, but must be incurred only after the decision is made. Finally,
relevant costs must be quantifiable.

Sunk costs.
A sunk cost is a past cost relating to a past decision. A sunk cost may be differential, but it is not
relevant because it is not a future cost. Many fixed costs are not relevant because they will be
incurred regardless of the investment decision. Methods of allocating, apportioning, or absorbing
overheads are also not relevant to the decision, and are not cash flows.

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Question 7
The AAA Motel Has the following costs associated with 2 projects.
Project 1 2
Annual costs:
Labour 13,000 15,000
Interest expense 1,500 500
Repairs 200 400
Classify the above costs into differential and irrelevant costs

Question 8
Mr Harry is considering the purchase of a new a kitchen range. He believes his present range, with a
major repair job, should last for another 6 years. In order to make a rational decision, Mr Harry
compiles the following data:
New Range Old Range
Cost of new range $5,000 Original cost $2,000
Estimated useful life 6 years
Annual operating costs:
Electricity $800 $700
Repairs $200 $500
Labour $10,000 $10,000
Estimated salvage value after 6 years $500
Estimated cost of required major repair $1,200
Estimated salvage value now $300
Estimated salvage value after 6 years $100

Produce a 6 year cost schedule using relevant costs so as to arrive at the best decision.

Question 9
The Grand hotel needs a new photo-copier. The owner has the following two alternatives:
Buy Lease
Cost of equipment $15,000 -
Annual rental cost $7,000
Salvage value in 3 years 2,000 -
Annual costs:
Labour 25,000 25,000
Interest expense 1,000
Repairs 1,500

Assume the copier has a 3-year life
Required:
1. Which costs are irrelevant?
2. Prepare a 3-year cost schedule for each alternative including relevant costs only.
3. Which alternative do you recommend?

Opportunity Costs.
The cost of the best alternative opportunity in a decision-making situation is the opportunity cost.
Opportunity costs are among the relevant costs considerations in decision-making situations. If the
decision-making process is rational, then the opportunity cost is less than the value associated with
the outcome of the decision.

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Question 10
The owner of the USG Inn is concerned about losses incurred in operating the Inns lounge. They have
identified three alternative actions:
a) Continue the lounge operation as it is
b) Close the lounge and expand the restaurant
c) Lease the space to Lounge Lease Inc. (LLI).

The following table summarises the USG Inns fully allocated monthly income statement:
Rooms Food Lounge Total
Sales $500,000 $200,000 $100,000 $800,000
Expenses 150,000 100,000 80,000 330,000
Departmental Profit 350,000 100,000 20,000 470,000
Allocated Overhead 200,000 80,000 30,000 310,000
Pre-tax Income 150,000 20,000 (10,000) 160,000
Less: Income Tax 60,000
Net Income 100,000

Additional Information:
a) Closing the lounge would reduce overhead costs by $10,000 per month. Leasing the lounge to LLI
would reduce overhead costs by $5,000 per month.

b) The space can be leased to LLI for 6% of sales. Annual forecasted lounge sales are expected to be
$1,000,000.

c) If the lounge is closed, room sales are expected to decrease by 3%, assume that departmental
expenses of rooms, food and lounge are all variable (10%) except for $100,000 of the rooms
departmental expenses, which are fixed. However, food department profits are expected to increase
by 10%.

d) Assume the cost to convert the lounge to restaurant space is $48,000 and the equipment will have
a four year life.

e) Assume the lounge space equipment, if sold will provide an annual cash flow of $6,000 per year.

Based on the above information, recommend the best alternative for the USG Inn lounge. Support
your recommendation with calculations.

Option B Option C Comments
a)

b)

C2)

C1)

d)

e)

f)

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C2) Rooms Actual After reduction in sales
Sales $ 500,000 Sales $ 485,000
V. cost $ 50,000 V. cost $ 48,500
Contribution $ 450,000 Contribution $ 436,500
Fixed Cost $ 100,000 Fixed Cost $ 100,000
Total $ 350,000 Total $ 336,500

Difference = $ 350,000 - $ 336,500 =

Average and Incremental costs
A company has the following cost structure for a product:
Fixed costs $2,000
Variable cost per unit $2.00

Calculate the average cost and incremental cost.

Number of units produced: 1,000 2,000
Total Variable cost: $2,000 $4,000
Fixed cost 2,000 2,000
Total cost 4,000 6,000
Average cost per unit $4.00 $3.00
Incremental cost per unit $2.00 $2.00
Total incremental cost $2,000

The total incremental cost is the difference between the total costs at the different levels of output. If
1001 units are produced you can see the difference in total cost will be $2.00 that is $4002 - $4,000

A common difference encountered between average and incremental costs concerns income taxes.
Consider a simple graduated tax rate as follows

Taxable Income Tax Rate
$20,000 and under 15%
Greater than $20,000 25%

The incremental taxes and average taxes paid on each dollar of taxable income up to $20,000 are 15
cents. Taxes on income in excess of $20,000 will be 25 cents for each dollar of taxable income. Thus
th
the incremental tax on the 25,000 dollar is 25 cents, while the average tax on $25,000 is 17%
calculated as follows:

Tax on the first $20,000: $20,000 x 0.15 = $3,000
Tax on the next $5,000: $5,000 x 0.25 = $1,250
Total Taxes $4,250

Average Tax = 4,250/25,000 = 17%

Other Questions
Question 1
The following, monthly income statement, has been prepared by the Sun Inn:

th
Sun Inn Income Statement for the month ending September 30 2011
Net Cost of Payroll & Other Income
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Revenues Sales Related Expenses Expenses (Loss)
Rooms $105,000 $0 $21,000 $1,500 $82,500
Food 50,400 20,160 15,120 1,500 $13,620
Bev 25,000 7,650 6,375 10,000 $ 1,475
Other 5,000 1,000 0 0 $ 4,000
185,900 28,810 42,495 13,000 101,595

Undistributed Operating Expenses:
Administrative & General 16,000
Information Systems 4,500
Marketing 3,500
Property operation & Maintenance 5,000
Utility Costs 15,500
Income after Undistributed Operating Expenses 57,095

Fixed Expenses:
Rent 5,095
Property Taxes 1,000
Insurance 2,000
Interest 3,500
Depreciation 5,500
Tax 10,000
Net Income 30,000

a) What are the direct costs of the rooms department?
b) What is the total of the overhead expenses for the period?
c) Which costs are considered controllable by the management?
d) Which costs are considered non-controllable by the management?
e) If food sales increased to $60,000 calculate the cost of sales

Question 2.
The Star Motel wishes to lease a building for food service. Two lease options are available:
(iii) Variable lease at 8% of sales
(iv) Mixed lease at $1,000 per month plus 4% of sales

a) What is the indifference point?
b) Assuming the average monthly sales are expected to be $20,000, calculate the cost of each lease
option
c) Based on your calculations in part (b), which option would you recommend?

Question 3.
A Pizza bar has the following costs at various levels of weekly sales:
Weekly sales in units 1,000 2,000
Materials $ 6,000 $ 12,000
Payroll costs 1,300 1,800
Lease 600 1,000
Supplies 600 1,200
Depreciation 500 500
Utilities 400 600
Other operating costs 300 600
Total 10,700 18,700

f) Identify the mixed costs.
g) Identify the variable costs
h) Identify the fixed costs
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i) Develop an equation to estimate costs at various levels of activity.
j) Project total costs with weekly sales of 3,400 units.

Question 4
The ZZ Motel is considering replacing the dishwashing system with a new system. Research costing
$250 has identified a new system that will cost $3,500. Although the old dishwasher has a book value
of $3,000, its present market value is only $1,500, and if kept for a further 5 years, this would drop to
$400. If the new system were not purchased the present dishwasher would need major repairs now
costing $700. The following are the expected annual expenses over the next 5 years for each option:
Keep Present Buy New
Dishwasher System
Annual expenses:
Maintenance $ 400 $ 400
Labour 4,000 3,800
Energy 500 500
Water 300 275
Detergent 150 100

The new system is expected to have a salvage value of $300 at the end of 5 years.

a) Which costs are sunk?
b) Which costs are irrelevant?
c) Prepare a 5-year schedule to show which alternative should be selected?

Question 5.
The owner of the Corn Inn is concerned about losses incurred in operating the Inns lounge. They have
identified three alternative actions;
b) Close the lounge and convert the space to a small meeting room
c) Lease the space to Cuba coffee shops

The following table summarises the Corn Inns fully allocated monthly income statement:
Rooms Food Lounge Total Departmental Profit
$300,000 $60,000 $20,000 $380,000
Pre-tax Income 150,000 30,000 (5,000) 175,000
Income Tax 45,000
Net Income 130,000

1) Closing the lounge would reduce overhead costs by $17,000. Leasing the lounge to Cuba Coffee
would reduce overhead costs by $7,000.

2) The space can be leased to Cuba Coffee for 6% of sales. Monthly forecasted lounge sales are
expected to be $20,000

3) If the lounge is closed, room profits are expected to decrease by 1%, while food department profits
are expected to increase by 10%

4) The cost to convert the lounge for alternative use is assumed to be equal to the market value of the
lounge equipment

5) The lounge space, if used for small meetings, is expected to yield pre-tax profits of $700 per month.

Based on the above information, recommend the best alternative for the Corn Inn
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lounge. Support your recommendation with calculations.

Question 6
The Gator Restaurant currently has a variable lease that is 6% of its total revenue. An alternative
approach is $120,000 per year fixed lease. Assume the average and marginal tax rates are 35% and
40% respectively.

Required:
a) Calculate the indifference point.

b) If annual sales are expected to be $3,000,000, which type of lease would you
recommend. Provide figures to support your choice.

c) Assume the Gator Restaurants indifference point is $1,500,000. What is the cost
net of tax, of making an error in signing a variable lease when annual sales are
$1,700,000?

Question 7
The Strand Palace Hotel produced the following monthly income statement.

The Strand Palace Hotel
Income Statement September 2011.
Rooms Food Bar Total

Revenue 600,000 500,000 300,000 1,400,000
Cost of sales 0 200,000 150,000 350,000
Payroll 120,000 200,000 12,000 332,000
Other direct costs 50,000 10,000 5,000 65,000
Department Income 430,000 90,000 133,000 653,000

Undistributed expenses: Payroll Other Total
Administration 70,000 20,000 90,000
Marketing 45,000 30,000 75,000
Property operation, maintenance
& Utility cost 40,000 65,000 105,000
Insurance 35,000 35,000
Depreciation 70,000 70,000
375,000
Net income before tax 278,000
Income Tax 68,000
Net Income 210,000

The owners of the Strand Palace Hotel would like to develop a fully allocated income statement using
the multiple allocation base approach (MABA). Indirect expenses should be allocated on the following
basis:
Indirect Expense Basis
Depreciation Square metres
Property operation, maintenance
& Utility Square metres
Marketing Ratio of sales
Administration Number of employees
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Additional information:
Department Book value of Square Number of
Fixed Assets Metres Employees

Rooms 10,700,000 50,000 60
Food 5,500,000 11,000 80
Bar 40,000 500 6
Administration 160,000 2,500 20
Marketing 100,000 1,000 14
Property operation,
Maintenance & Utility 1,000,000 5,000 10
Required:

a) Prepare a fully allocated income statement for the Strand Palace Hotel.

b) Discuss the action that you would recommend to the management of the Strand Palace Hotel
following your preparation of the fully allocated income statement.

Question 8
The D.K. Pizza House has provided you with the following information on costs at various levels of
monthly sales.

Monthly sales in units 3,000 6,000 9,000
Cost of food sold ($) 4,500 9,000 13,500
Payroll costs ($) 3,500 5,000 6,500
Supplies ($) 600 1,200 1,800
Utilities ($) 360 420 480
Other Operating Costs ($) 1,500 3,000 4,500
Rent ($) 1,000 1,000 1,000
Depreciation ($) 200 200 200
Total ($) 11,660 19,820 27,980

Required:
a) Classify each cost by its behaviour.
b) Develop an equation to estimate total costs at various levels of activity
c) Project monthly costs if monthly sales were 8,000 units

Question 9
Kents Inn needs new laundry equipment. Two alternatives are available as follows:

Buy Lease
Cost of Equipment $20,000 -
Annual rental - $6,000
Salvage value in 5 years 1,000 -
Annual costs:
Labour 15,000 15,000
Interest expense 1,500 -
Repairs 200 -

Additional information:
Assume that the laundry equipment has a five year life.

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Required:
a) Which costs are irrelevant?
b) Prepare a 5 year cost schedule for each alternative
c) Which alternative do you recommend?

Question 10
Paul Smith is considering replacing the present dishwasher with a new energy efficient model.
Although the old dishwasher has a net book value of $1,000, its current market value is $2,000 and, if
held for five more years, this would drop to $300. If the new machine is not bought, approximately
$500 of repairs would be necessary on the present dishwasher. The following is the expected annual
expenses for each option over the next five years.
Keep old machine Buy new machine
Maintenance $400 $200
Labour 12,000 12,000
Energy 800 500
Water 400 400
The new machine would cost $7,000 with a salvage value of $2,000 in five years.
Required:
a) Which costs are irrelevant
b) Draw up a five year schedule and decide on which option to choose

Question 11
The owner of the ABC Inn is concerned about losses incurred in operating the Inns lounge. They have
c) Lease the space to Lounge Lease Inc. (LLI).

The following table summarises the ABC Inns fully allocated monthly income statement:
Sales $300,000 $100,000 $100,000 $500,000
Expenses 100,000 50,000 80,000 230,000
Pre-tax Income 100,000 10,000 (10,000) 100,000
Net Income 75,000
a) Closing the lounge would reduce overhead costs by $10,000 per month. Leasing the lounge to LLI

b) The space can be leased to LLI for 6% of sales. Annual forecasted lounge sales are expected to be
$1,000,000.

c) If the lounge is closed, room profits are expected to decrease by 3%, however, food department
profits are expected to increase by 10%. Assume that departmental expenses of rooms, food and
lounge are all variable except for $50,000 of the rooms departmental expenses, which are fixed.

a four-year life.

e) Assume the lounge space equipment, if sold will provide an annual cash flow of $6,000 per year.

Based on the above information, recommend the best alternative for the ABC Inn lounge. Support

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Question 12
The owner of the Rose Inn is concerned about losses incurred in operating the Inns lounge. They have
b) Close the lounge and convert the space to a small meeting room
c) Lease the lounge to Bevco.

The following table summarises the Rose Inns fully-allocated monthly income statement:
Pre-tax Income 50,000 5,000 (5,000) 50,000
Net Income 30,000

a) Closing the lounge would reduce overhead costs by $7,000 per month. Leasing the lounge to Bevco

b) The space can be leased to Bevco for 5% of sales. Annual forecasted lounge sales are expected to
be $150,000.

profits are expected to increase by 20%. Assume that departmental expenses of rooms, food and
lounge are all variable.

d) Assume the cost to convert the lounge for alternative use is assumed to be equal to the market
value of the lounge equipment.

e) The lounge space, if used for small meetings, is expected to yield a pretax profit of $3,000 per
month.

Based on the above information, recommend the best alternative for the Rose Inn lounge. Support

Question 13
The owner of The Big Star Hotel is concerned about losses incurred in operating the hotels lounge.
They have identified three alternative actions:

c) Lease the space to Philip Inc., a management company.

The following table summarises The Big Star Hotels fully allocated monthly income statement:
Sales $250,000 $100,000 $ 40,000 $390,000
Departmental expenses* 100,000 70,000 20,000 190,000
Pre-tax Income 50,000 5,000 (10,000) 45,000
Net Income 25,000

17
Cindy Aluisa
00125773
* Assume all departmental expenses to be variable.

a) Closing the lounge would reduce overhead costs by $10,000 per month. Leasing the lounge to
Philip Inc., would reduce overhead costs by $5,000 per month.

b) The space can be leased to Philip Inc., for 10% of sales. Annual forecasted lounge sales are
expected to be $550,000.

profits are expected to increase by 20%.

a life of five years with no salvage value.

e) If the lounge is closed, the lounge equipment can be sold on a contract over five years and $500
will be received each month.

Based on the above information, recommend the best alternative for the USG Inn lounge. Support
18

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