Question

What costs are relevant when determining how many pizzas a month Zume Pizza must sell to break even?
Zume Pizza uses a combination of robots, artificial intelligence (AI), and GPS in its food trucks to deliver pizzas to customers’ houses just as the pizza is finished baking. Pizzas are actually prepared and baked in the Zume pizza truck by an employee assisted by robots. Zume Pizza started operations in April 2016 and is currently selling about 250 pizzas per day.
The pizza delivery process starts with a customer using Zume Pizza’s app to order pizza. The pizza combinations offered by Zume have been derived by analyzing customer data to offer several popular options. These preset combination recipes are programmed into Zume’s computers, so that its robots can build and bake the pizzas efficiently.
All pizza preparation and baking happens in the Zume pizza truck. Once the customer orders a pizza, a worker in the Zume food truck will toss the dough, cut the vegetables, and put on toppings. A robot will put on the pizza sauce. Each Zume pizza truck has 56 pizza ovens, which are each individually connected to the order system and the truck’s GPS. A robot will put the pizza into the designated oven exactly four minutes before the truck reaches the customer’s house. A worker will pull out the pizza when it is finished and place it into the cutter, where a robot will cut the pizza. The pizza is boxed and the pizza is delivered to the customer’s door, all within a few minutes of finishing baking. Eventually, Zume’s owners hope to use a robot to remove pizzas from the oven as well.
Assume that average selling price per pizza is about $18. To follow are estimates of costs that might be incurred by Zume Pizza in its pizza business.
Description of cost Cost estimate Ingredient cost per pizza $ 6.00 Truck fuel cost per delivery $ 3.00 Cost of pizza delivery truck (estimated useful life 5 years, no salvage value) $ 80,000 Cost of initial software development (estimated useful life 3 years) $ 30,000 Annual maintenance/update costs of software $ 25,000 Supplies cost per pizza (box, napkins, etc.) $ 1.00 Cost to park pizza delivery truck per year (garage facility) $ 24,000 Insurance and other regulatory costs per year $ 36,000 Cost of cofounders' salaries per year $ 150,000 Cost to rent restaurant kitchen facility for testing and food prep (per year) $ 45,000 Direct labor cost per pizza (driving truck and preparing pizza in truck) $ 5.00  

  

Source: Wendy Tietz, PhD, CPA, CMA, AccountingintheHeadlines.com This work is licensed under a Creative Commons Attribution-NonCommercial 3.0 Unported License.  
Questions
1. From the list above, what costs would you classify as variable with respect to the cost of a Zume pizza? Are there any other variable costs you could envision that Zume might incur per pizza? Explain. 2. From the list above, what costs would you classify as fixed with respect to the cost of a Zume pizza? Are there any other fixed costs you could envision that Zume might incur in its pizza business? Explain. 3. What costs from the list and any costs you thought of for Questions #1 and #2 above would you use to calculate the break even number of pizzas that Zume Pizza must sell per day? Why did you included these costs? Calculate the break even number of pizzas. 4. Given your answer for the current break even number of pizzas, calculate Zume’s margin of safety in number of pizzas (if any margin of safety exists.) What does this margin of safety mean?

Answer 1

Ans 1: The variable costs with respect to the cost of a Zume pizza from the list above are as follows:

a)- Ingredient Cost Per Pizza - $ 6
b)- Truck Fuel Cost Per Delivery - $ 3
c)- Supplies Cost Per Pizza - $ 1
d)- Direct Labor Cost Per Pizza - $ 5

Total Variable Cost Per Pizza = $ 15

Apart from these, Marketing Costs and additional costs during any event or sale period could be considered as a variable cost in a business like this because Marketing expenses will rise gradually as the business picks up and hence it is a variable cost.

Ans 2: The fixed costs with respect to the cost of a Zume pizza from the list above are as follows:

a)Depriciation Cost Of Pizza Delivering Truck - $ 80,000/5=$16,000
b)depriciation Cost Of Initial Software Development - $ 30,000/10=$10,000
c)Annual Maintenance / Update Costs - $ 25,000
d)Cost To Park Pizza Delivery Truck - $ 24,000
e)Insurance And Other Costs - $ 36,000
f)Co Founder's Salaries - $ 150,000
g)Restaurant Kitchen Rent - $ 45,000

Total Fixed Costs: $ 306,000 / Year

Apart from these costs, any kind of selling and administrative expenses can be a fixed cost because if the sales go up they might need a General Manager or Supervisor who would take a fixed salary which would add up their fixed costs.

Ans 3: Break Even Number Of Pizzas = Total Fixed Cost / Contribution Margin
= $ 306,000 /( $ 18 - $ 15)

= $ 306,000/ $ 3

= 102,000 Pizzas

We would use the Total Fixed Cost which we have calculated in Answer 2 and the Total Variable Cost/Unit which we have calculated in Answer 1. We have included these costs because, to calculate the break even point we need to know the total fixed costs and the contribution margin.

Ans 4: Margin Of Safety = Actual Sales - Break Even Point

= (250 x 365 x $ 18) - (102,000 x $ 18)

= $ 1,642,500 - $ 1,836,000

= - $193,500

Since there is a negative margin of safety, we can say that the operations will lose money and there should be a additional sales of $ 193,500 to break even operationally. In other words, 10,750 more pizzas should be sold in one year to operationally break even.

Margin Of Safety is the revenue earned after the company or department pays all of its fixed and variable costs associated with producing the goods or services.