Question

Amy Richardson had been a well-paid sales manager of a major hotel chain for 15 years. Due to a hotel owner's illness, Amy was offered the opportunity to purchase a hotel near a seaside vacation area she had often visited. After obtaining a lawyer and a financial accountant to assist her, Amy did an analysis of the most recent financial statements of the hotel. Since the hotel had consistently shown a profit during the past few years, Amy thought that the price of the hotel was reasonable, so she decided to purchase the hotel. She resigned her position, obtained a loan, and purchased the hotel.

During the first year as a hotel manager, Amy received an offer from a tour operator who proposed to guarantee a considerable number of room reservations, including during the off-season. However, she turned down the offer because the tour operator asked for a 20% price reduction compared to the regular room rate. A few weeks later, she decided to shut down the restaurant, located in the main building of the hotel, in order to save expenses. With regard to general expenses, she was particularly concerned with the high room cleaning and service costs. On the sales side, although the reservations for the cheaper standard rooms were a bit sluggish, the more expensive large-size superior rooms had a very good occupancy rate of over 90%. The following year, there was a severe economic downturn and also a very bad weather season that reduced the number of guests and also caused a resulting mold situation in the hotel building that required expensive repair work. Amy ran short of cash, became emotionally distraught, and eventually had to sell the hotel at a significant loss.

Question:

Analyze Amy’s purchase decision and the subsequent events using the following key management accounting tools and concepts: Cost-Volume-Profit Analysis, Using Relevant Costs to Make Short-Term Decisions, Cost Management Using Full Costs and Budgeting. Make sure that you clearly indicate how each tool/concept could be used to explain potential management errors that Amy had made and could have helped her to improve decision-making and the financial results of the business.

Answer 1

Cost Volume Profit Analysis looks in to the impact of cost and volume on operating profit. CVP analysis also known as break even analysis to calculate break even point. Break even point is that the point at which companies revenue is equal to fixed post..

CVP Analysis makes certain assumption that the selling price, fixed cost and variable cost per unit is constant. CVP analysis determines the changes in cost affects companies profitability.

Amy Richardson has been purchased hotel by obtaining loan. She resigned her position in hotel to acquire hotel.

However her salary income is called as cost of opportunity. And opportunity cost is considered as relevant cost to determine cost of purchase decision.

Relevant cost concept-

Relevant cost is the cost that is considered as relevant in order to make decisions. Variable cost is relevant cost but fixed cost is not relevant in making decisions. Here opportunity cost , interest on loan cost variable cost to run hotel are taken in to account to make purchase decision.

Cost management using full cost and budgeting

Cost management using Full cost method means assignment of all cost including direct, indirect, fixed, variable cost to product or service. Through this method it is ascertained that the actual cost to make product or service. This method of costing generally used to determine total cost required for making product or service. On the other hand cost management through budgeting means cost planning before actual spending. It involves how much cost we may bear for particular product or service. Cost management through budgeting should take in to account variable cost and also all fixed cost to calculate product cost. Before any project implementation it necessary to make cost management plan that takes in to account all factors and components of cost and expected results.

Evaluation of plan can be made by comparing actual results with budgeted cost .

In this case Amy Richardson has make certain errors while acquiring hotels.

First she should be taken in to account present profitability of hotel business.

Rate of occupancy of rooms and hotels through out the year. Identify season in which occupancy is high. And based on this cost decision should take.

CVP analysis is important that helps us to understand impact of cost changes on profit. Also important to calculate Break even point to determine when the revenue from operation will cover fixed cost.

She should thought on offer from tour operator, by calculating BEP. It is required to determine whether 20% reduction in price will cover BEP. If it even only cover BEP, necessary to consider the offer to running hotel and to retain customer that helps to grow business in future.

While acquisition of hotels it is necessary to takes in to account relevant cost. And managing cost by full cost method.

Budgeting before acquisition of hotels it is an important costing technique to ascertain cost that helps to ascertain profitability on acquisition.

However it is recommended that Amy Richardson should take in to accounts costing methods to determine accurate product cost that helps her to take decision.