Question

Thomaham’s Simply Delicious

Two couples, the Thomases and the Abrahams, have been neighbors for over 15 years.  They discovered that the four of them have exceptional baking skills.    They have all traveled extensively, taken baking classes, and have each worked in respectable, prestigious bakeries and restaurants.

Over the years they have united their baking skills and baking passions and have taken advantage of every opportunity to distribute their baked good to family and friends.  It did not take long before  their mere sharing of baked goods developed into orders.   The Thomases and Abrahams found themselves in the catering business.   That is, they were quite often hired to cater the dessert section of menus for wedding, parties, banquets, etc.     

About two and a half years ago, the Thomaham’s SImply Delicious Companywas legally formed and licensed to do business.     Demand grew such that their kitchens were deemed too small for business.   They relocated to a much larger facility and have a small staff of workers.   The Thomases and Abrahams expanded their operations to include private catering as well as placement in grocery stores.    Consequently, they recently retained the services of Tina Randolph, a CPA, to assist them in managing the financial affairs of the company.    The Thomases and Abrahams see a profitable future for Thomaham’s SImply Delicious Company.   They have asked Tina to focus specifically on growth and profitability.  

Ms. Randolph has determined that there is a need for a lot of cost analysis, especially regarding the determination of the cost of baking their specialty, cookies.   Her goal is to determine a product costing system that can be used for pricing decisions and product-line planning and budgeting.  She has asked you, one of her summer management interns, to provide basic information that would serve as a starting point.    You provided Exhibit 1 showing actual costs and revenue data for 2019.    During that year Thomaham sold 12,800 baked items (cakes, pies, etc.)  for approximately $30 each.

After receiving the information, Ms. Randolph asked you to further  classify the expense as a product (direct material, direct labor, or factory overhead) or period costs and (2) classify each of the expenses as either variable,  fixed, or mixed .      She asked that you clearly justify the classification you assign to each expense.  

Next, Ms. Randolph wants you to determine breakeven for Thomaham’s based on your classifications in (2) above.  You can consider any mixed costs to be 40% variable, and 60% fixed.     What is your evaluation of how Thomaham is doing relative to breakeven?  

>>>Write a thorough memo to Ms. Randolph in response to her request.   Be sure to present your responses clearly.   You may present exhibits to accompany your memo.

Exhibit 1.

Thomaham Simply Delicious Company
Income Statement
For the Year Ended December 31, 2019
Sales ($30 per baked item)		$384,000
Expenses:
Raw materials (Baking)	$163,967
Labor (Bakers' salaries)	99,384
Wages (General Bakery area, hourly)	28,684
Supplies (General Bakery area)	1,942
Shipping to Customers  (delivery truck)	13,888
Electricity (general baking area)	8,700
Water (general baking area)	2,147
Routine Monthy Maintenance (general baking area)	7,380
Wireless and Telephone (Administrative)	1,150
Salaries-Owners (administrative)	50,000
Sales Commission  (salesforce)	12,334
Total Expenses		389,576
Net Income		($5,576)

Answer 1

Memo

To: Tina Randolph, CPA

From: ABC, Intern

Date: january 5, 2020

Subject: Break Even Analysis of Thomaham Simply Delicious Company

Ms. Tina Randolph,

I have classified the expenses as per your request and have also attached a Break Even Analysis based on the data collected.

Have provided the reason why I have categorised an expense as Mixed, Variable and Fixed.

Then I have proceeded to find the Break Even Point so as to enable optimal pricing of the bakery product.

Hope it serves the purpose.

Part - I Classification of Expenses

Expense	Type	Reason	Amount in $
Raw materials (Baking)	Variable	Raw Materials is depended on level of Orders received. If Orders are more, more of Raw Materials is required for Baking	1,63,967
Labor (Bakers' salaries)	Fixed	We should pay the bakers a fixed amount as salary irrespective of how many baking orders are received	99,384
Wages (General Bakery area, hourly)	Variable	As the wages are to paid on hourly basis, it is dependent on demand of orders	28,684
Supplies (General Bakery area)	Fixed	As it is for general purpose an estimated cost would be incurred throughout the period under consideration	1,942
Shipping to Customers  (delivery truck)	Variable	The Bakery Items are to be delivered to each customer individually. So we'll incur shipping costs for each order	13,888
Electricity (general baking area)	Mixed	Electricity is mixed expense as it has a fixed tariff even in case of non-usage and the tariff is at an increasing trend , the more units of electricity is consumed higher would be the costs. Higher units would be used if there are high demands and Kitchen Equipments use a lot more electric power	8,700
Water (general baking area)	Mixed	Water Charges is mixed expense as it has a fixed tariff even in case of non-usage and the tariff is at an increasing trend , the more units of water is consumed higher would be the costs. Higher units would be used if there are high demands as water is an essential ingredient in Baking Business	2,147
Routine Monthy Maintenance (general baking area)	Fixed	These Expenses are routine and pre-determined. It won't change as result of higher demand of products.	7,380
Wireless and Telephone (Administrative)	Fixed	These Expenses are routine and pre-determined. It won't change as result of higher demand of products.	1,150
Salaries-Owners (administrative)	Fixed	These Expenses are routine and pre-determined. It won't change as result of higher demand of products.	50,000
Sales Commission  (salesforce)	Variable	Sales Commission is paid on the volume of sales generated by the Salesforce. Higher the sales bought to the company higher their commission and vice-versa. It is directly linked to Sales which is variable	12,334
Total Expenses			3,89,576

Part-II Break Even Analysis

Thomaham Simply Delicious Company
Statement of Profit and Break Even Point
Particulars	[Units]	Working	[Amount in $]
Units Sold	12,800	Given
Price	30	Given
Revenue		[12,800*30]	3,84,000
Variable Expenses	17.44	[2,23,212/12,800]	2,23,212
Contribution		=Revenue-Variable Expenses =[3,84,000-2,23,212]	1,60,788
Contribution per unit		=[160,788/12,800]	13
PV Ratio (%) Profit Volume Ratio		=[Contribution/Revenue] *100 [160,788/3,84,000]*100	41.87%
Fixed Cost			1,66,364
Profit		=[Contribution – Fixed Cost] = [1,60,788 - 1,66,364]	(5,576)
BEP* in Units (Nos)		=[ Fixed Cost/Contribution p.u] =[1,66,364/13]	13,244
BEP* ( Amount)		=[ Fixed Cost/PV Ratio] =[1,66,364/41.87%]	3,97,335

* Break Even Point

As you can observe Total Expense = Total Revenue when units are 13,244.

So we have two altrnatives.

1. Increase the Price from $30 to $30.5 [30.44] Precisely. An Increase in price will help in achieving Break Even Point with same level of production of Bakery Items.
2. Increase the production of Bakery Items to 13,244 units approx 13,245 units will help in achieving Break Even Point;

if the company cannot increase their level of production they should go for Alternative - 1

if the company cannot increase their pricing per unit they should go for Alternative - 2.

The above two alternatives are just from my perspective and some more alternatives can be found out by holding a meeting with Ms. Tina Randolph, Shareholders/Directors of Thomaham Simply Delicious Company.

I would also would like to be a part of meeting as I have crunched some numbers, I can help with some queries/clarifications.

--------------------------------------------------------------------------------------------------------------------------------------------------- End of Memo ---------------------------------------------------------------------------------------------------------------------------------------

Further the evaluation Ms. Tina Randolph, is apt as the company was incurring losses it had to come up with a strategy.

She has assessed it rightly that a strategic plan is required to make the business proftable. It would be her job to point out the facts and workout numbers so that she can help in decision making of the company.

Note for Bifurcating Mixed Expense into Fixed and Variable. Fixed - 60% Variable - 40%

Expense	Type	Amount in $
Raw materials (Baking)	Variable	1,63,967
Labor (Bakers' salaries)	Fixed	99,384
Wages (General Bakery area, hourly)	Variable	28,684
Supplies (General Bakery area)	Fixed	1,942
Shipping to Customers  (delivery truck)	Variable	13,888
Electricity (general baking area)	Mixed	-
[Segregated into Fixed and Variable]	Variable	3,480
	Fixed	5,220
Water (general baking area)	Mixed	-
[Segregated into Fixed and Variable]	Variable	859
	Fixed	1,288
Routine Monthy Maintenance (general baking area)	Fixed	7,380
Wireless and Telephone (Administrative)	Fixed	1,150
Salaries-Owners (administrative)	Fixed	50,000
Sales Commission  (salesforce)	Variable	12,334
Total Expenses		3,89,576