This example is one that I have used in the past to introduce Activity-Based costing to my students. Because there are not a lot of new terminology and complex numbers involved, it may be helpful in learning the concepts involved in ABC costing.
Chicago Grill is a new restaurant. In the past, Chicago Grill has used a costing system based on estimated costs (other than the cost of food and drinks) for the year divided by estimated number of diners for the month. For the upcoming month, Chicago Grill estimates $230,000 in total costs, and has also calculated that about 20,000 diners will use the restaurant. Based on this calculation, they calculate that the applied overhead cost will be $11.50 per diner. And this is not including the cost of food and drinks!
The owner of the restaurant, Judy, thinks that perhaps these costs may be somewhat inaccurate. It takes as much effort and time in some cases to serve a single diner as it does to serve a party of 4. She has other questions: is it more expensive to serve a party of diners that eat just an entrée and leave, or it is more expensive to serve a party of drinkers that may share one appetizer among 4 people?
She asks you to help her determine some of the costs of operating the dining room, in addition to the actual food and drink costs. After studying her operations for a day, you have come up with the following information:
Overhead and other costs of operating the restaurant can be divided into the following subcost groups (only costs not included relevant to restaurant costs are the actual materials cost of food and drinks):
1) cost of serving a table of diners (ANY SIZE GROUP)
2) cost per diner
3) cost per drink ordered.
4) Cost per plate of food (any size: entrée, dessert, salad, etc.)
You have determined that (aside from the actual costs of the food and drinks themselves):
1) total costs of serving tables will come to about $120,000 for the month.
2) Total costs of serving diners will be an estimated $25,000
3) Costs of serving drinks will be around $25,000.
4) Costs of serving plates of food will be around $60,000
1) the restaurant will serve an estimated 10,000 tables in the upcoming month.
2) An estimated 20,000 people will use the restaurant
3) 50,000 drinks will be consumed.
4) 200,000 plates of food will be served.
Based on your findings, what would be the cost of serving:
a) a party of 7 that orders 2 drinks and each has an appetizer
b) An individual diner that has no drinks but has an entrée, a salad and a dessert?
c) A party of 10 that orders 25 drinks and no food?
d) A party of 2 that orders 4 drinks and one family special, which consists of one plate divided among 2 people?
For each answer, what would be the a) total cost of serving the party and b) the average cost per diner in the party?
What can you conclude from your calculations? If this is a new restaurant with no established clientele yet, how would you suggest that the owner position her business? (as a wild and crazy bar, as sedate and formal dining experience or as something else?)
The solution is given below. Students can probably work this problem without being given the solution but the solution can help them verify the answer and help them see what benefit might come from switching to an activity-based costing system.
First calculate the individual activity rates, or rates per table, per diner, per plate, and per drink. Then, using those rates, you can easily determine the cost of each of the above parties.
So for the first one, cost of serving tables (each time a table is seated, there is a cost incurred) would be calculated by dividing the total of $120,000 by 10,000 tables to get $12/table. The others then are, for diner cost: ...
You will find the answer to this puzzling question inside...