To Savor or to Groupon?

Mr. Chang, the owner of Enter the Dragon, a high-end Asian restaurant in Chicago, was puzzled by the choices put before him by the Groupon sales representative. He could offer a daily deal at Groupon (a $60 coupon for $30) that would be seen by hundreds of thousands of Groupon subscribers in the Chicago region, or he could offer a more tailored discount at Savored, a restaurant reservation site also owned by Groupon. Business had been slow lately, especially during weeknights, and Mr. Chang wanted to spur demand. He wanted to make sure, however, that he did so in a way that actually increased profits. He estimated that demand on weeknights was normally distributed, with a mean of 60 and a standard deviation of 30. Given a capacity of 100 and only a single seating per table per night, there were empty tables on many nights.

Groupon and the Daily Deal

Launched in 2008, Groupon expanded rapidly on the basis of its daily deals. The daily deal amounted to a 50 to 70 percent discount coupon for a product or service offered by a local business. The deal was broadcast by Groupon to its subscribers; if the number of buyers exceeded a threshold, the deal was finalized and the company shared about half the revenues with the local business while keeping the rest as its commission. The local business thus received about 20 to 25 cents on the dollar of retail value. Customers who purchased a coupon using the daily deal then contacted the local business for their product or service. At restaurants like Enter the Dragon, Groupon buyers tended to get their reservations as soon as they purchased their coupon, which was well before regular customers tried to get their reservations. The popularity of the daily deal among subscribers led to rapid growth at Groupon. After rejecting a $6 billion offer from Google, the company went public in 2011. Its stock has had a turbulent journey since then. After opening at $25, the stock hit a low of $4 by the end of 2012 before recovering to $10 by early 2014. The drop in price could be attributed in part to the higher marketing costs and the negative publicity from some retailers who had used the daily deal. Some complained that “the financials just can’t work,”2 whereas others called Groupon the “worst marketing ever.” Retailers complained that while Groupon brought in new customers, the margins were terrible because the 20 to 25 cents on the dollar recovered from a Groupon deal was much lower than the revenue the new customers provided. A very popular blog post by Jay Goltz on the New York Times3 site offered retailers a way to evaluate the benefit of the daily deal. He suggested that retailers think of Groupon as advertising. Instead of writing a check to the advertising agency, retailers using the daily deal were choosing to lose money on sales. Thus, the only calculation that mattered was the cost per new customer acquired from a daily deal. The blog post suggested the following eight key metrics to decide whether the daily deal was cost effective advertising:

1. Incremental cost of sales

2. Size of the average sale

3. Percentage of coupons redeemed

4. Percentage of coupons purchased by current customers

5. Number of coupons purchased per customer

6. Percentage of new coupon customers who become regular customers

7. Value of all Groupon subscribers seeing the daily deal

8. Current cost to acquire new customer through advertising

The value of the daily deal depended on these numbers. In an example described on the blog, Mr. Goltz focused on a restaurant that sold 3,000 coupons with a face value of $75 for $35 (the restaurant received only $17.50, with Groupon keeping the rest as commission). He assumed that the restaurant spent 40 percent (of normal revenue, not discounted revenue) in incremental cost; customers spent, on average, $85 ($10 more than the coupon); only 85 percent of the coupons were redeemed; 40 percent of the coupons were purchased by current customers; two coupons were purchased per customer; and about 10 percent of the new customers came back to the restaurant. In this case, the restaurant received a check of $52,500 (= 3000 * 17.50) from Groupon and additional revenues of $25,500 (= 3000 * 0.85 * 10) because the customers who came to the restaurant spent $10 more than the face value of the coupon. The incremental cost of serving these customers was $86,700 (= 3000 * 0.85 * 85 * 0.40). The restaurant thus lost $8,700 on this deal. If viewed as advertising expense, it was necessary to evaluate the number of new repeat customers that the deal brought in. Given that 2,550 (= 3000 * 0.85) coupons were redeemed and each customer bought two coupons, the deal was used by a total of 1,275 customers. Given that 60 percent of these were new customers, the deal brought 765 (= 1275 * 0.6) new customers to the restaurant. If 10 percent of them would return, the deal effectively brought in 76 new repeat customers. The restaurant then had to decide whether spending $8,700 to bring in 76 new repeat customers was more effective than other forms of advertising.

Savored and Restaurant Discounts

Groupon acquired Savored, a restaurant reservation engine, in September 2012. Savored offered discounts of up to 40 percent at upscale restaurants as long as customers made the reservations online in advance. Restaurants could vary the discount offered by time of day and day of week, with larger discounts for less popular times. Restaurants could

also vary the number of tables available at the discount price. Savored suggested times when discounts should be offered after studying a restaurant’s traffic patterns. For example, all Saturday night slots at the Capital Grille on Wall Street were discounted because it attracted a workweek crowd, whereas the Fatty Crab in the West Village in Manhattan offered only a Saturday night discount at 11 p.m.4 Savored had helped restaurants manage their idle capacity effectively. Le Cirque, an upscale Manhattan restaurant, had eliminated its cheaper pre-theater menu because Savored reservations filled those slots.

Study Questions

Use the spreadsheet Chapter16-Groupon for any supporting analysis.

1. Assume a variable cost of $10 per table and an average spending of $60 per table. With the daily deal ($60 for $30 coupon), Groupon provides Mr. Chang with a revenue of $15 per table. The analysis provided in the New York Times blog indicates that Mr. Chang makes money ($5 per table) through the daily deal (rather than incurring advertising expense). Do you think the analysis has included all aspects that need to be considered? Should Mr. Chang go ahead with the daily deal given that he can advertise while making a little bit of money per coupon?

2. With Savored, Mr. Chang can limit the number of tables he allows for the discount price. Assuming he makes the same revenue with Savored per discounted table as the daily deal ($15), do you think the ability to limit the number of tables at discount has any advantages? Would you prefer to use Savored or the daily deal?

3. Would you prefer to use Savored or the daily deal? Why?

Eastman Publishing Company is considering publishing an electronic textbook about spreadsheet applications for business. The fixed cost of manuscript preparation, textbook design, and web-site construction is estimated to be $150,000. Variable processing costs are estimated to be $7 per book. The publisher plans to sell single-user access to the book for $49.

Equipment:

The project involves the purchase of a new machine. The machine costs $500,000 is depreciable over 5 years. The machine requires a new building which would cost another $250,000 (we assume that the construction of the building takes place at t=0). The building is also depreciable over 5 years. The building will occupy a field bought 2 years ago for $200,000. The best other use for the field is as a parking lot for employees. The post-tax present value of employee parking for the life of the project is $65,000. In spite of the fact that the building and the machine will be fully depreciated, the company is expected to sell the machine and the building to a competitor for a total salvage value of $200,000 after the 5 year project is complete.

Project Operation:

At the beginning of year 1, the firm will need to increase its noncash working capital by $600,000, fully recovered at the end of the project in five years. The expected quantities of the new product sold to customers would be: Year 1 (ie: at t=1) 400 units; Year 2: 400 units; Year 3: 400 units; Year 4 and 5: 700 units. The sale price of the product is expected to be $1,000 during the first three years and then to grow by 10% each year. The “per unit cost” is expected to be $300 for the duration of the project.

      Other:

      The tax rate is 35%. The discount rate is 10.5%.

Blue Plate Construction organized in December and recorded the following transactions during its first month of operations.
Dec. 2    Purchased materials on account for $400,000.
Dec. 3    Used direct materials costing $100,000 on job no. 100.
Dec. 9    Used direct materials costing $150,000 on job no. 101.
Dec. 15    Used direct materials costing $30,000 on job no. 102.
Dec. 28    Applied the following direct labor costs to jobs: job no. 100, $9,000; job no. 101, $11,000; job no. 102, $5,000.
Dec. 28    Applied manufacturing overhead to all jobs at a rate of 300% of direct labor dollars.
Dec. 29    Completed and transferred job no. 100 and job no. 101 to the finished goods warehouse.
Dec. 30    Sold job no. 100 on account for $200,000.
Dec. 31    Recorded and paid actual December manufacturing overhead costs of $78,000, cash.
Dec. 31    Closed the Manufacturing Overhead account directly to Cost of Goods Sold.

    Record each of these transactions as illustrated in the Job Order Costing section.

    Compute the amount at which Cost of Goods Sold is reported in the company’s income statement for the month ended December 31.

    Determine the inventory balances reported in the company’s balance sheet dated December 31.

    Was manufacturing overhead in December overapplied, or was it underapplied? Explain.

Miller, Inc. manufactures construction equipment and farm machinery tires. For the month of June, year 1, Miller expects to produce 2,500 tires and sell the same number at $1,000 per tire. Budgeted selling and administrative costs for the tires (all fixed) are expected to equal to $50,000. The standard costs per tire are as follows:

Actual results for June differed from the budgeted results. Miller produced 2,300 tires, but sold only 2,000 at a price of $1,050 per tire. Actual fixed selling and administrative costs were $60,000. Actual production costs also differed from the standard:

Compute the production cost variances, showing your work below.

Blue Plate Construction organized in December and recorded the following transactions during its first month of operations.
Dec. 2    Purchased materials on account for $400,000.
Dec. 3    Used direct materials costing $100,000 on job no. 100.
Dec. 9    Used direct materials costing $150,000 on job no. 101.
Dec. 15    Used direct materials costing $30,000 on job no. 102.
Dec. 28    Applied the following direct labor costs to jobs: job no. 100, $9,000; job no. 101, $11,000; job no. 102, $5,000.
Dec. 28    Applied manufacturing overhead to all jobs at a rate of 300% of direct labor dollars.
Dec. 29    Completed and transferred job no. 100 and job no. 101 to the finished goods warehouse.
Dec. 30    Sold job no. 100 on account for $200,000.
Dec. 31    Recorded and paid actual December manufacturing overhead costs of $78,000, cash.
Dec. 31    Closed the Manufacturing Overhead account directly to Cost of Goods Sold.

a. Record each of these transactions as illustrated in the Job Order Costing section.

b. Compute the amount at which Cost of Goods Sold is reported in the company’s income statement for the month ended December 31.

c. Determine the inventory balances reported in the company’s balance sheet dated December 31.

d. Was manufacturing overhead in December overapplied, or was it underapplied? Explain.

Eastman Publishing Company is considering publishing an electronic textbook about spreadsheet applications for business. The fixed cost of manuscript preparation, textbook design, and web-site construction is estimated to be $160,000. Variable processing costs are estimated to be $6 per book. The publisher plans to sell single-user access to the book for $46.

Practice Exercise 11-2 In 1990, Carla Vista Company completed the construction of a building at a cost of $900,000 and first occupied it in January 1991. It was estimated that the building would have a useful life of 40 years and a salvage value of $27,000 at the end of that time. Early in 2001, an addition to the building was constructed at a cost of $225,000. At that time, it was estimated that the remaining life of the building would be, as originally estimated, an additional 30 years, and that the addition would have a life of 30 years and a salvage value of $9,000. In 2019, it is determined that the probable life of the building and addition will extend to the end of 2050, or 20 years beyond the original estimate. Using the straight-line method, compute the annual depreciation that would have been charged each year from 1991 through 2000. Annual depreciation from 1991 through 2000 $ / yr Compute the annual depreciation that would have been charged from 2001 through 2018. Annual depreciation from 2001 through 2018 $ / yr Prepare the entry, if necessary, to adjust the account balances because of the revision of the estimated life in 2019. (If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Credit account titles are automatically indented when amount is entered. Do not indent manually.) Account Titles and Explanation Debit Credit Compute the annual depreciation to be charged, beginning with 2019. Annual depreciation expense—building $

The Humpty Doo Rare Earths Mining Company started mining operations on 1 July 2019. In the year to the 30^th June 2020 three areas were explored, Europium, Gadolinium, and Terbium. The following costs were incurred:

Rare earths were discovered at Europium on 17^th January 2020. In April 2020 after a review of the prospects for the Gadolinium site it was decided to abandon operations there. Exploration was still a work in progress at the Terbium site, but no decision had been made about the commercial potential of that site. Development of the Europium site had continued during the year and at 30^th June 2020 $36 million had been incurred. These costs are to be written off on a production basis.

This cost relates to the construction of plant and equipment. It is estimated that there are 150,000 tonnes of rare earth which has a current sale price of $3,500 per tonne. By the 30^th June 2020 15,000 tonnes had been extracted at a production cost of $6 million of which 12,000 tonnes were sold.

Required

Record this first year’s transactions by journal entry using the area of interest method.

The Humpty Doo Rare Earths Mining Company started mining operations on 1 July 2019. In the year to the 30^th June 2020 three areas were explored, Europium, Gadolinium, and Terbium. The following costs were incurred:

Rare earths were discovered at Europium on 17^th January 2020. In April 2020 after a review of the prospects for the Gadolinium site it was decided to abandon operations there. Exploration was still a work in progress at the Terbium site, but no decision had been made about the commercial potential of that site. Development of the Europium site had continued during the year and at 30^th June 2020 $36 million had been incurred. These costs are to be written off on a production basis.

This cost relates to the construction of plant and equipment. It is estimated that there are 150,000 tonnes of rare earth which has a current sale price of $3,500 per tonne. By the 30^th June 2020 15,000 tonnes had been extracted at a production cost of $6 million of which 12,000 tonnes were sold.

Required

Record this first year’s transactions by journal entry using the area of interest method.