the bakery a cross-functional case study for introductory managerial accounting

Case

The Bakery:a cross-functional case study for introductory

managerial accounting§

Stacy E. Kovara,*, Kristin Evansb

aDepartment of Accounting, Calvin 109, Kansas State University, Manhattan, KS 66503,USAbCessna Aircraft Co., USA

Received 1 November 1999; accepted 1 August 2001

Abstract

This instructional case is designed to achieve four educational objectives: (1) to give stu-dents a more complete appreciation of the importance of considering accounting information

along with marketing and economics-related information, avoiding a myopic focus onaccounting data, (2) to give students practice in pricing, cost volume profit analysis (CVP) andoutsourcing decisions, (3) to help students learn to build spreadsheets that are capable of

what-if analysis, and (4) to provide an active learning experience that engages introductoryaccounting students. The Bakery is a non-profit organization whose primary function is to sellbaked goods and beverages to students in a large campus residence hall complex. In com-pleting the case, students utilize information provided about the costs and previous pricing

structure of The Bakery, along with information they collect about competitors’ productofferings, prices, and accompanying services, and their own knowledge of The Bakery’s cus-tomers, college students and their parents, as a basis for making pricing decisions. Once they

have completed the pricing analysis, students use the resulting variable costing income state-ment to perform CVP and to analyze a decision to potentially outsource The Bakery’soperations. # 2002 Elsevier Science Ltd. All rights reserved.

Keywords: Pricing; Managerial accounting; Cost volume profit analysis; Outsourcing; What-if analysis

J. of Acc. Ed. 19 (2001) 283–303

www.elsevier.com/locate/jaccedu

0748-5751/02/$ - see front matter # 2002 Elsevier Science Ltd. All rights reserved.

PI I : S0748-5751(01 )00020 -3

§ This case study is based on an actual organization and decision process. The second author was the

financial manager described in the case. The Bakery is located in one of the residence hall complexes at

Kansas State University. All data are actual, though aggregation and rounding have been used to facil-

itate simplicity of presentation.

* Corresponding author. Tel.: +1-785-532-6083; fax: +1-785-532-5959.

E-mail address: [email protected] (S.E. Kovar).

1. Background

The Bakery, a retail bakeshop located within housing and dining services of XYZState University, first opened in 1990. The business was established by the campus-wide, non-profit housing and dining service to provide baked goods, includingbreakfast and dessert items, to students who live in the residence halls. Hotel and res-taurant management students originally operated The Bakery. These students were incharge of the selling and management functions of the operation, but civil serviceemployees produced the baked goods. The only exception to these procedures wasthat students baked the cookie dough in the shop during normal business hours.Prices for all products sold by The Bakery were determined by the student man-

agers, who set prices based on what they considered to be reasonable for the market.These prices have remained the same since The Bakery began operating and areshown in Table 1.

2. A new financial manager

You have been brought in as the new financial manager of The Bakery. Aftertalking with your supervisor, Mr. Smith, you decide that the pricing of the productsneeds to be reevaluated and updated. Mr. Smith is concerned that some productprices may be out of line when considering the cost to make each item. He empha-sizes to you that setting fair prices based on the relative cost to produce each item isa priority to The Bakery because of its mission of serving students. You and Mr.Smith agree that relative prices for different products should be based on directmaterials cost only, because other costs of manufacturing individual products (suchas labor and overhead) would be difficult to determine. You also agree that otherfactors like competitor and customer characteristics should be kept in mind. Mr.Smith adds that you should, ‘‘Remember in setting your prices that we are here toserve the students and not to generate a profit. I feel that a student should not haveto pay more than $1.50 for any regular single-serve item that we have on our menu.Of course, this does not apply to things like large and extra large cookies, cakes, andvariety bags, which contain several items packaged in a decorative container. Inaddition, I am afraid if you raise the price of any item more than 25%, students willbecome upset and may stop coming to The Bakery. Finally, for ease of use, all pricesshould be rounded to 5-cent increments.’’

3. Additional information

3.1. Costs

Based on the information that Mr. Smith has provided, you decide that it is bestto first determine the direct materials cost for each product sold by the Bakery. Thisinformation has been gathered and is provided in Table 2.

284 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283–303

Your next concern is the cost of labor and overhead needed to run the organiza-tion. The average weekly labor cost for all student employees is $450. One student isavailable at all hours when the store is open. There is not enough space in the storefor more than one person to work. Overhead consists of the costs of maintaining thearea where The Bakery is located (maintenance includes large items like paintingand replacing countertops), The Bakery’s share of utilities, janitorial, and otherservices. These costs, amounting to about $40 per week, are determined based on aformula, but Mr. Smith indicates that he expects them to remain fairly constant aslong as the size of The Bakery does not change. The cost of salaries for the civilservice employees who prepare the baked goods is categorized as direct labor. Whileit might be possible to change these costs in the long run, Mr. Smith estimates thatthey will remain constant at $200 per week as long as total revenues are in a normalrange, which is from about $800–1500.

3.2. Competition

After thinking about the costs for The Bakery, you turn your thoughts to TheBakery’s competitors. You should identify competitors for the Bakery, given the

Table 1

Original prices

Menu item Price

16 oz. Bottled juice $0.90

Milk $0.3012 oz. Coffee $0.4014 oz. Soft drink $0.50

20 oz. Soft drink $0.6033 oz. Soft drink $0.909�1300 cake $9.00

18�1300 cake $12.00900 Round cake (2 layer) $10.50Large cookie $3.00

Extra large cookie $6.00Classic baga $3.00Gourmet baga $3.50

XYZ-State baga $4.00Jumbo cinnamon roll $0.75Regular cinnamon roll $0.50

Jumbo pecan roll $1.00Regular pecan roll $0.75Muffin $0.40

Turnover $0.50Bagel $0.40Classic cookie $0.30

Gourmet cookie $0.50Brownie $0.50Rice Krispie treat $0.75

a These items are designed for gift-giving. They consist of several items, such as a bottled Minute Maid

juice, brownie, cookie, etc. in a decorative container.

S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283–303 285

nature of its customers and products offered. Once identified, you should visit andevaluate these competitors to determine how the products and services they offer willinfluence the prices for The Bakery’s products.

4. Customers and demand

Most items at The Bakery are purchased by students. The average student at XYZState University is 20 years old, lives in a residence hall, and goes to school full time.There is one exception to this pattern. A few larger items—cakes, large cookies, andvariety bags (Classic, Gourmet, and XYZ-State bags)—are primarily bought overthe phone and through the mail by parents to be delivered to their children for spe-cial occasions.Weekly demand data for The Bakery are provided in Table 2. These numbers were

estimated by averaging weekly sales data for the past 12 months.

Table 2

Direct materials cost and weekly demand

Menu Item Direct Mat. Costs Avg. Weekly Demand

16 oz. Bottled juice $0.60 46

Milk $0.15 20

12 oz. Coffee $0.13 9

l4 oz.Soft drink $0.08 22

20 oz.Soft drink $0.14 33

33 oz. Soft drink $0.24 55

9�1300 Cake $1.33 6

18�1300 Cake $2.94 4

900 Round cake (2 layer) $2.25 3

Large cookie $0.50 4

Extra large cookie $0.99 6

Classic baga $1.44 2

Gourmet baga $1.55 3

XYZ-State baga $1.66 4

Jumbo cinnamon roll $0.22 35

Regular cinnamon roll $0.09 41

Jumbo pecan roll $0.48 21

Regular pecan roll $0.24 25

Muffin $0.10 152

Turnover $0.12 32

Bagel $0.30 40

Classic cookie $0.05 96

Gourmet cookie $0.11 261

Brownie $0.35 68

Rice Krispie treat $0.35 156




5. Requirements

1. Before beginning the assignment, think about how costs, constraints, compe-tition, and customer characteristics should influence the prices of The Bakery’sproducts and, consequently, how you should go about determining the prices.Be explicit for each item. Consider The Bakery’s objective of fair pricing, asindicated by Mr. Smith, as well as the organization’s non-profit status.

2. After you have completed requirement 1, create a spreadsheet to collect/com-pute necessary information to help in setting prices. Your spreadsheet shouldbe designed so that changes can easily be made to costs, constraints, compe-titor prices, and weekly demand. It should allow the user to quickly see theeffect of these changes on cost-based prices and income. To accomplish this,the spreadsheet should have four individual worksheets.(a) The first worksheet, the input sheet, should be where all of the given infor-mation is entered - previous prices, costs, weekly demand, fixed costs for laborand overhead, and any other data you collect.(b) The second worksheet, the computations worksheet, should show compu-tations for the markup percentage, initial prices based on markup, and anyconstraint-related values. In addition to other necessary columns to showcomputations clearly and neatly, the computations worksheet should have acolumn showing the ‘maximum price’ for each of the products based on thevarious ‘constraints’ identified by you and Mr. Smith. The last column in thecomputations worksheet should allow the user to judgmentally select and enterthe new menu price for each item by looking at information provided in theworksheet as well as other factors he or she wants to consider. At the bottomof the column, the total revenue, total cost, and net income resulting from thefinal prices should be shown so that the user can see the effect of price changes.Two worksheet functions will be useful to you as you build your spreadsheet:

sumproduct (range1, range2)

range1 and range2 are columns of values, for example, A1:A3 and B1:B3.The sumproduct function will multiply values in range1 by the correspond-ing values in range2, and then sum the products down the column(A1�B1+A2�B2+A3�B3). This function may be useful as you are com-puting total revenue and total cost.

mround (number, multiple)

Number is a number or formula to be rounded. Multiple is the multiple toround to. Rounding is normally to the nearest multiple of 1, 10, .1 or .01,although mround can round to any multiple desired. For example, to round$554.20 to the nearest 25-cent increment, use mround(554.20,.25). The resultwill be 554.25. This function is useful for rounding the prices to 5-centincrements as required by Mr. Smith.


(c) The final worksheets, the output worksheets, should present the price listand a contribution margin income statement in clearly readable form. The usershould not have to do anything to produce the price list and the income state-ment. They should be automatically computed from the values entered on thefirst two worksheets.

3. Once you have completed your spreadsheet, use it as well as other informationabout customers and competition to arrive at prices for the products. Prepare areport for Mr. Smith describing how your spreadsheet works and the steps youused for setting prices, including a description of the role of costs, constraints,competition, and customers in motivating your decisions. Your report shouldnot be more than two pages, single-spaced with 1-inch margins and a reason-able font size. In addition to the two-page report, you should include a print-out of your pricing worksheets, price list, and income statement.

4. Assume that Mr. Smith has received your report and accompanying worksheetsand is impressed. Mr. Smith was intrigued by the variable costing incomestatement you showed him. He has never seen an income statement where costswere divided into variable and fixed categories and thinks this might have somepotential. He has asked you for recommendations for using this information.You remember an earlier conversation with Mr. Smith where he indicated

that The Bakery’s weekly sales are actually very erratic, depending not only onwhether the semester is in session, but also on the time of the semester, with salesbeing much higher during times such as finals week.Mr. Smith was complaining atthe time that, while he can usually predict total sales for any given week based onpast experience, this variability makes it tedious estimating the income/loss forThe Bakery each week as required by housing and dining services. You also recallthat Mr. Smith had once been very concerned when housing and dining serviceswas going to dramatically increase the cost of overhead charged to The Bakery.He spent some time in his office computing the effect of a potential increase.Write a memorandum explaining to Mr. Smith the value of the variable

costing income statement and describing how he can use information fromyour average weekly income statement to (1) develop a model and quicklypredict income for any given week when an estimate of total sales is known,and (2) identify the effect of changes in factors such as total overhead cost onThe Bakery’s profitability. Bear in mind that Mr. Smith will not want to haveto estimate total sales of each individual item to make predictions. Describe theassumptions that would have to be made for the model to result in accuratepredictions. As you describe your model, include examples for Mr. Smithwhere you predict the income for a week where total sales are expected to be$1500 and evaluate the effect of an increase in overhead costs to $190.

5. Mr. Smith has decided he would like for you to use your spreadsheet to eval-uate the effect of a possible change in the Bakery’s operations that he has beenconsidering. This change would involve having Java, a local bakery and coffeehouse, make the goods to be sold in The Bakery. Java has an excellent repu-tation and Mr. Smith believes that weekly demand for all of the productswould increase by 25% if the baked goods were purchased instead of


produced. Java would charge The Bakery 250% of the materials cost (materi-als costs are shown in Table 2) for the completed baked goods. Outsourcingthe production of The Bakery items would not influence the amount of generaloverhead applied to The Bakery.Mr. Smith would like to know what effect this outsourcing decision would

have on the prices that The Bakery must charge. Would the prices have to beincreased, or could they be decreased? If a consistent percentage price adjust-ment were applied to all of the prices you computed in the previous step, whatwould the percent be? What other, possibly non-quantitative, factors should beconsidered when making the decision? Include with your answers copies ofyour new data entry and computation spreadsheets.

6. Teaching note for the Bakery

6.1. Objectives

Though it could be used in a junior-level cost course, this case is designed forintroductory managerial accounting students. This case gives students an opportu-nity to practice the computations required for determining markups based on cost,to set prices in a realistic setting, to prepare a very simple variable costing incomestatement, to use the income statement for cost volume profit analysis (CVP), and toperform what-if analysis for an outsourcing decision. The case requires students toconsider accounting information in the context of marketing and economics-relatedinformation. The case also helps students learn to build spreadsheets that are cap-able of what-if analysis. It accomplishes this by guiding them through the steps ofstructuring a spreadsheet with separate data entry, computation, and output work-sheets, which facilitate what-if analysis, and by giving them experience in using thespreadsheet for this purpose. To achieve to these learning objectives, the case con-text is a familiar organization, a bakery serving students living in residence halls ona college campus. To further engage students, they are required to seek out infor-mation about customers and competitors in their own community.

6.2. Suggestions for use in the classroom

This case consists of three parts—a portion dealing with setting prices (case require-ments 1-3), another part addressing CVP analysis (requirement 4), and a third partrequiring use of what-if analysis to evaluate an outsourcing decision (requirement 5).Though the pricing portion of the case must be completed in order to cover theother two parts, both the CVP and outsourcing/what-if aspects of the project areoptional. An obvious time for assigning this case is while covering chapters wherecost behavior and pricing and outsourcing decisions are discussed. Another possibletime to discuss the case is when budgeting is discussed. The case can be used to accent-uate the importance of pricing and demand forecasting in the budgeting process as wellas the usefulness of a variable costing income statement for making projections.


This case is best completed in groups of three–four students because students caneasily divide responsibilities for checking competitors’ prices and products, com-puting cost-based prices, writing the report, and performing the what-if analysesdescribed in the last requirement, thus reducing the total time devoted to the case.However, students must ultimately work together to arrive at a final set of prices,articulate the tradeoffs that guided their decision process, and communicate theCVP and outsourcing results, which helps to lessen the risk of unequal participationand assures that all students understand all aspects of the case.I distribute the case description immediately following a 30-minute lecture on

pricing. The assignment for the next class period is to complete two problems(unrelated to the case) requiring computation of product prices using the procedurediscussed in this solution. Students must also read the case, answer the questions inrequirement No. 1, and assess (1) what tasks will be necessary to complete the caseand (2) how these tasks could be divided among the students in their group. Duringthe next class period, the practice problems are briefly discussed and students aregiven time (20 minutes) in class to coordinate with their group. Students areinstructed that they should plan to spend approximately three additional hoursworking on the case and two additional hours meeting with their group. The nexttopics to be covered in class are CVP (needed for requirement 4) and special decisions(relevant to requirement 5). These topics are covered in their entirety prior to thedue date of the case. Additional group meeting times can be provided either in oroutside of class. In-class meetings help alleviate schedule conflicts and encourageequal participation, but can be time consuming.It is possible to assign the case either with or without a follow-up in-class discus-

sion. In the event that time is available for an in-class discussion, on the due date, Ifirst draw a table on the board or on a transparency with column headings for eachof the four general factors considered in setting prices—costs, constraints, competi-tion, and customers. Drawing attention to the cost column, I present the markupand cost-based price computation in the first three columns of the solution shown inTable 3, on a separate transparency or by actually projecting the spreadsheet,depending on the technology available. Students generally are able to arrive at thecorrect computation with little assistance. At this point, I draw attention to thestructure of the spreadsheet, with separate columns for input and computations,noting that none of the cells on the computations sheet (not even the descriptions ofthe products) actually contain raw ‘data’, but instead refer to data on the input sheetshown in Table 4.Next, I ask the students to identify the constraints they faced while setting prices.

These constraints and their role in setting prices are discussed in the next section ofthis solution. Once these are listed on the board, I display columns 4–7 of Table 3.Following this, groups are polled to identify the two most interesting factors,

other than costs and constraints, that they considered in setting prices. As studentsstate their factors, the audience classifies the points addressed by that group asrelated to cost, customers, competitors or constraints. Once all of the presentationsare complete, the grid on the board can be reviewed and the class and instructor cancomplete the grid by adding any considerations not mentioned. This board plan


Table 3

Price computation worksheets—computations sheet

1 2 3 4 5 8 7 8

Item Cost basis Markup % Unit

Cost�markup

Prev.

Price +25% limit

Single

Serve Limit

Comp.

Price Limit

Max price

(min of 4,5,6)

Final price

16 oz. Bottled juice $0.60 355% $2.13 $1.13 $1.50 $1.05 $1.05 $1.00

Milk $0.15 355% $0.53 $0.38 $1.50 $0.60 $0.40 $0.40

12 oz. Coffee $0.13 355% $0.46 $0.50 $1.50 $0.85 $0.50 $0.50

l4 oz.Soft drink $0.08 355% $0.28 $0.63 $1.50 $0.75 $0.65 $0.60

20 oz.Soft drink $0.14 355% $0.50 $0.75 $1.50 $0.85 $0.75 $0.75

33 oz. Soft drink $0.24 355% $0.85 $1.13 $1.50 $1.05 $1.05 $1.00

9�1300 Cake $1.33 355% $4.72 $11.25 $14.00 $11.25 $11.00

18�1300 Cake $2.94 355% $10.44 $15.00 $20.00 $15.00 $15.00

900 Round cake (2 layer) $2.25 355% $7.99 $13.13 $19.00 $13.15 $13.00

Large cookie $0.50 355% $1.78 $3.75 $5.00 $3.75 $3.75

Extra large cookie $0.99 355% $3.52 $7.50 $8.00 $7.50 $7.50

Classic bag $1.44 355% $5.11 $3.75 $3.75 $3.75

Gourmet bag $1.55 355% $5.51 $4.38 $4.40 $4.40

XYZ-State bag $1.66 355% $5.90 $5.00 $5.00 $5.00

Jumbo cinnamon roll $0.22 355% $0.78 $0.94 $1.50 $1.00 $0.95 $0.80

Regular cinnamon roll $0.09 355% $0.32 $0.63 $1.50 $0.75 $0.65 $0.50

Jumbo pecan roll $0.48 355% $1.70 $1.25 $1.50 $1.25 $1.25 $1.00

Regular pecan roll $0.24 355% $0.85 $0.94 $1.50 $0.85 $0.85 $0.75

Muffin $0.10 355% $0.36 $0.50 $1.50 $0.85 $0.50 $0.50

Turnover $0.12 355% $0.43 $0.63 $1.50 $0.75 $0.65 $0.60

Bagel $0.30 355% $1.07 $0.50 $1.50 $0.85 $0.50 $0.50

Classic cookie $0.05 355% $0.18 $0.38 $1.50 $0.50 $0.40 $0.30

Gourmet cookie $0.11 355% $0.39 $0.63 $1.50 $0.75 $0.65 $0.50

Brownie $0.35 355% $1.24 $0.63 $1.50 $0.95 $0.65 $0.60

Rice Krispie treat $0.35 355% $1.24 $0.94 $1.50 $0.95 $0.90

(continued on next page)

S.E.Kovar,K.Evans/J.ofAcc.

Ed.19(2001)283–303

291

Table 3 (continued)

1 2 3 4 5 8 7 8

Item Cost basis Markup % Unit

Cost�markup

Prev.

Price +25% limit

Single

Serve Limit

Comp.

Price Limit

Max price

(min of 4,5,6)

Final price

Total materials cost $270.37

Civil service labor 200.00

Other overhead 40.00

Student labor 450.00

Total cost $960.37

Total Revenue $960.37 $1043.63 $1049.90 $951.10

Total Variable Cost $270.37 $270.37 $270.37 $270.37

Contribution Margin $690.00 $773.26 $779.53 $690.73

Total Fixed Costs 690.00 690.00 690.00 690.00

Net income/(Loss) $0.00 $83.26 $89.53 $0.73

*Markup computation

Total revenue $960.37

Divided by cost basis $270.37

Markup percentage 355%

292


Ed.19(2001)283–303

helps to emphasize that all four general factors must be considered and to also bringout the fact that some considerations jointly relate to more than one category. Forexample, factoring in the distance required to travel to a potential competitor’s placeof business considers both the characteristics of the customer (does not want totravel far) and the competitor (what level of convenience do they offer). Finally, Idisplay the final column of the solution shown in Table 3.Following this discussion, I discuss the CVP question (Requirement 4) and eval-

uate the outsourcing scenario (Requirement 5). The numerical solution to the CVPanalysis is reasonably straightforward, so I focus on discussion of the assumptions.In addressing the outsourcing scenario, I try to spend time polling students askingthem what types of modifications they had to make to their spreadsheet in order toevaluate the scenario. Generally, students have made more significant modificationsthan would have been necessary had they anticipated what-if analysis in advanceand carefully adhered to the instructions of separating data input and computations.This leads smoothly to a discussion of how important it is to consider what-if ana-lysis, as well as potential changes in operations, when designing spreadsheets.

Table 4

Price compution worksheet—input sheet

Civil Service Labor 200.00

Other Overhead 40.00

Student Labor 450.00

Item Materials cost per unit Weekly demand Competitor price Previous price

16 oz Bottled juice $0.60 46 $1.05 $0.90

Milk 0.15 20 0.60 0.30

12 oz. Coffee 0.13 9 0.85 0.40

14 oz. Soft drink 0.08 22 0.75 0.50

20 oz. Soft drink 0.14 33 0.85 0.60

33 oz. Soft drink 0.24 55 1.05 0.90

9�1300 Cake 1.33 6 14.00 9.00

18�1300 Cake 2.94 4 20.00 12.00

900 Round cake (2 layer) 2.25 3 19.00 10.50

Large cookie 0.50 4 5.00 3.00

Extra large cookie 0.99 6 8.00 6.00

Classic bag 1.44 2 3.00

Gourmet bag 1.55 3 3.50

XVZ-State bag 1.66 4 4.00

Jumbo cinnamon roll 0.22 35 1.00 0.75

Regular cinnamon roll 0.09 41 0.75 0.50

Jumbo pecan roll 0.48 21 1.25 1.00

Regular pecan roll 0.24 25 0.85 0.75

Muffin 0.10 152 0.85 0.40

Turnover 0.12 32 0.75 0.50

Bagel 0.30 40 0.85 0.40

Classic cookie 0.05 96 0.50 0.30

Gourmet cookie 0.11 261 0.75 0.50

Brownie 0.35 68 0.95 0.50

Rice Krispie treat 0.35 156 0.75


Many different solutions are possible for this case depending on the competitiveenvironment and student characteristics at the particular school. Supporting com-putations for one possible solution to the case are presented in Tables 3 and 4 (Inputand Price computation worksheets), Table 5 (Variable costing income statement),Table 6 (New price listing), and Tables 7 and 8 (Input and Price computationworksheets for outsourcing what-if). The solution presented below addresses thepricing, CVP, and outsourcing sections of the case separately.

6.3. Pricing solution

The pricing portion of the case should focus on four pricing-related considera-tions—costs, constraints, customers, and competition.

6.3.1. CostsThe steps for computing prices based on a markup over cost are as follows:

1. determine total budgeted cost for the business;2. determine desired profit and revenue;3. determine which costs will be associated with individual items;4. determine the markup percentage; and5. determine prices based on cost and the markup percentage.

To compute total cost for The Bakery, one must first compute total materials costfor each item using the data in Table 2. Then, fixed costs for student labor, over-head, and civil service labor are added to the result to get total cost. Instead ofcreating a separate spreadsheet column for total cost, the spreadsheet shown inTable 3 uses the sumproduct(CostBasisColumn, WeeklyDemandColumn) function inExcel to multiply the basis shown in column 1 of Table 3 (the cost basis is thematerials cost per unit from the input worksheet in Table 4) by the average weeklydemand quantities which have been entered on the input worksheet in Table 4. Thissaves space in the worksheet and makes it a bit easier to follow.Once total budgeted cost is determined, the desired profit and corresponding rev-

enue should be computed. For The Bakery, total profit should be zero. Thus, thetotal revenue for The Bakery should be the same as the total cost in Table 3, $960.37per week. Relative prices for items sold at The Bakery are based on the direct

Table 5

Variable costing income statement

Revenue $961.10

Variable costs 270.37

Contribution margin $690.73

Fixed costs 690.00

Net income/(loss) $0.73


materials cost per unit, as stated in the case description. The markup percentage iscalculated as follows:Markup=total revenue/total materials cost=$960.37 / 270.37=355%The prices for all products on The Bakery’s menu, computed using this markup,

are shown in column 3 of Table 3.

6.3.2. Alternative methods for computing initial pricesAfter demonstrating these computations, I ask students if anyone used a different

method for computing prices. Upon seeing some of the unrealistic prices resultingfrom setting prices based on materials cost, each semester at least one group decidesto set prices using a percentage increase over the previous price.I use this opportunity to discuss the inherent differences between cost-based and

market-based pricing. Using a flat price increase emphasizes the importance ofmarket-based prices and consistent price increases across all products. The cost-based method, on the other hand, is aimed at fair pricing based on the cost to pro-duce the individual item and is, therefore, more consistent with Mr. Smith’semphasis.

Table 6

New price listing

Menu item Price

16 oz. Bottled Juice $1.00

Milk $0.40

12 oz. Coffee $0.50

14 oz. Soft drink $0.60



9x1300 Cake $11.00

18�1300 Cake $15.00

900 Round cake (2 layer) $13.00

Large cookie $3.75

Extra large cookie $7.50

Classic baga $3.75

Gourmet baga $4.40

XYZ-State baga $5.00

Jumbo cinnamon roll $0.80

Regular cinnamon roll $0.50

Jumbo pecan roll $1.00

Regular pecan roll $0.75

Muffin $0.50

Turnover $0.60

Bagel $0.50

Classic cookie $0.30

Gourmet cookie $0.50

Brownie $0.60

Rice Krispie Treat $0.90




Table 7

Price computation worksheet for outsourcing what-if— computations sheet

1 2 3 4 5 6 7 8

Item Cost basis *Markup % Unit

cost�markup

Prev.

price +25% limit

Single

serve limit

Comp.

price limit

Max. price

(min of 4,5,6)

Final price

l6 oz Bottled juice $1.50 158% $2.37 $1.13 $1.50 $1.05 $1.05 $1.00

Milk $0.38 158% $0.59 $0.38 $01.5 $0.60 $0.40 $0.40

12 oz. Coffee $0.33 158% $0.51 $0.50 $1.50 $0.85 $0.50 $0.50

14 oz Soft drink $0.20 158% $0.32 $0.63 $1.50 $0.75 $0.65 $0.60

20 oz Soft drink $0.35 158% $0.55 $0.75 $1.50 $0.85 $0.75 $0.75

33 oz Soft drink $0.60 158% $0.95 $1.13 $1.50 $1.05 $1.05 $1.00

9�1300 Cake $3.33 158% $5.25 $11.25 $14.00 $11.25 $11.00

18�1300 Cake $7.35 158% $11.61 $15.00 $20.00 $15.00 $15.00

900Round cake (2 layer) $5.63 158% $8.89 $13.13 $19.00 $13.15 $13.00

Large cookie $1.25 158% $1.97 $3.75 $5.00 $3.75 $3.75

Extra large cookie $2.48 158% $3.91 $7.50 $8.00 $7.50 $7.50

Classic bag $3.60 158% $5.69 $3.75 $3.75 $3.75

Gourmet bag $3.88 158% $6.12 $4.38 $4.40 $4.40

XYZ-State bag $4.15 158% $6.56 $5.00 $5.00 $5.00

Jumbo cinnamon roll $0.55 158% $0.87 $0.94 $1.50 $1.00 $0.95 $0.80

Regular cinnamon roll $0.23 158% $0.36 $0.63 $1.50 $0.75 $0.65 $0.50

Jumbo pecan roll $1.20 158% $1.90 $1.25 $1.50 $1.25 $1.25 $1.00

Regular pecan roll $0.60 158% $0.95 $0.94 $1.50 $0.85 $0.85 $0.75

Muffin $0.25 158% $0.39 $0.50 $1.50 $0.85 $0.50 $0.50

Turnover $0.30 158% $0.47 $0.63 $1.50 $0.75 $0.65 $0.60

Bagel $0.75 158% $1.18 $0.50 $1.50 $0.85 $0.50 $0.50

Classic cookie $0.13 158% $0.20 $0.38 $1.50 $0.50 $0.40 $0.30

Gourmet cookie $0.28 158% $0.43 $0.63 $1.50 $0.75 $0.65 $0.50

Brownie $0.88 158% $1.38 $0.63 $1.50 $0.95 $0.65 $0.60

Rice Krispie treat $0.88 158% $1.38 $0.94 $1.50 $0.95 $0.90

(continued on next page)

296


Ed.19(2001)283–303

Table 7 (continued)

1 2 3 4 5 6 7 8

Item Cost basis *Markup % Unit

cost�markup

Prev.

price +25% limit

Single

serve limit

Comp.

price limit

Max. price

(min of 4,5,6)

Final price

Total materials cost $844.91

Civil service labor –

Other overhead 40.00

Student labor 450.00

Total cost $1334.91

Total revenue $1334.91 $1304.53 $1312.38 $1201.38

Total variable cost $844.91 $844.91 $844.91 $844.91

Contribution margin $490.00 $459.63 $467.47 $356.47

Total fixed costs 490.00 490.00 490.00 490.00

Net income (loss) $0.00 ($30.38) ($22.53) ($133.53)

*Markup computation

Total revenue $1334.91 Revenue Shortfall (needed increase in NI) $133.53

Divided by cost basis $844.91 Divided by total revenue before shortfall $1201.38

Markup percentage 158% Percent increase (decrease) in prices 11%


Ed.19(2001)283–303

297

6.3.3. ConstraintsWhen reviewing students’ lists of constraint-related pricing factors, I emphasize

that the constraints in this case result from organizational policies established byMr. Smith that enforce the mission and values of the organization—to provide fairlypriced, affordable goods to students.Column 7 of Table 3 shows the maximum price The Bakery can charge based on

these constraints. The maximum is the smallest of three amounts (1) the maximumprice based on a 25% increase over previous prices, which is found in Column 4, (2)the $1.50 single serve limit, found in column 5, or (3) the competitors’ price, foundin column 6. To select the maximum price and round it to the nearest 5-cent incre-ment as required by Mr. Smith, the following formula is used:

¼ mround min column4; column5; column6ð Þ; :05ð Þ

The ‘mround’ function is used to round all values to 5-cent increments. The ‘min’function selects the binding constraint, which is smallest of the three constraintvalues from columns 4–6.Comparing the cost-based prices with the maximum prices based on constraints

reveals that a number of the cost-based prices are simply too high and others are notvery realistic when common prices for these items are considered. For example, thecost-based price of a bottle of Minute Maid juice turns out to be $2.13 while thisitem generally sells for $1.00–$1.50 in competing stores. On the other end of thespectrum, the cost-based price for a muffin is $.36 while the least expensive sellingprice in competing stores is $.85. Therefore, a systematic evaluation of The Bakery’scompetitors and customers is needed both to serve as a basis for deciding whichproduct prices can reasonably be raised and to adjust prices to realistic levels, whereappropriate.1

6.3.4. CompetitionI like to tie together the discussion of competition and customer factors by intro-

ducing the economic concepts of price elasticity of demand and product substitutes.Economic theory suggests that the reaction of consumers to changes in prices islargely determined by their price elasticity of demand, defined as the percentagechange in quantity demanded divided by the percentage change in price. Greater

1 Though most students recognize the need to increase some prices because the prices, as adjusted for

constraints, are not high enough to cover cost, it is surprising how many do not immediately realize that

the prices are unrealistic. It is for this reason that the case description specifically indicates that students

should consider competitor and customer factors. Additionally, it is important to reiterate at this point

the importance of a lecture or reading assignment covering some of the economic and marketing con-

siderations involved in setting prices. This coverage can be a very important determinant of students’

ability to take a structured, cross-functional approach to the case, as many students may have only limited

background in marketing and economics and need this guidance. Additionally, for students who are not

required to take marketing and economics courses (i.e. non-business majors), this may be the only expo-

sure they get to these concepts. As a result, some presentation of marketing and economics concerns is

needed so that coverage of pricing issues is not unduly biased toward accounting considerations.


elasticity exists when competitors offer viable substitutes. Marketing theory suggestsproduct characteristics that might be important in evaluating whether a competitor’sproduct is a valid substitute. These include function, quality, accompanying services,ease of acquisition, and price.The analysis of potential substitute products will vary depending on the school

where the case is used. Generally, one might want to consider the quality of thebaked goods offered by competitors (a bakery and a convenience store offer verydifferent products), how easy the competitor is to access (especially on a residentialcampus), the availability of products comparable to the items offered by The Bakery(especially the variety bags), and the availability of delivery for cakes and largecookies which may be purchased by parents from another city. At XYZ state, theonly easily accessible competitor to offer a product of similar quality to The Bakeryat a comparable price is the student union. The student union does not carry largecakes, cookies or variety bags. While the local grocery store has a bakery offeringcakes and large cookies, they do not provide delivery service, which reduces but doesnot eliminate their viability as a competitor. Consequently, column 6 of Table 3shows the student union’s prices for the single-serve items and the grocery storebakery’s prices for large cookies and cakes. These prices, along with customerinformation, will be used as a basis for evaluating the reasonableness of the initialprices and making adjustments.

6.3.5. CustomersThe economic concept of price elasticity of demand can also be used to model how

customer characteristics may influence decisions about pricing. Four important fac-tors discussed in the marketing literature may influence customers’ willingness tochange buying patterns and therefore their elasticity:

1. the customer’s degree of need for the product;2. the customer’s perceptions of quality, status, or uniqueness for the product;3. the attractiveness of accompanying services, given the customer’s needs; and4. the customer’s ability to pay.

In terms of the above four characteristics, students, who probably have a mealplan through the dormitory cafeteria to provide for most of their needs, demonstratea moderate degree of need for the product. However, because snack items like thosefrom The Bakery often represent a spontaneous purchase, perceived need may behigh at the time of purchase. The Bakery’s products do offer a change of pace fromdormitory food, therefore most students would consider them of relatively highquality, particularly the fresh-baked cookies. Accompanying services are unim-portant for the single-serve items purchased by students. Finally, many studentsoften have a fairly low ability to pay. As a result, students are assessed as havingmoderate to high price sensitivity.Parents, who are the main customers for cakes, large cookies, and variety bags,

are likely to value the convenience of a delivered gift for their son or daughter for abirthday or other special event and can pay a higher price for this convenience. As aresult, parents are expected to have a low degree of price elasticity.


6.3.6. Setting the final pricesOnce prices have been adjusted downward as needed to reflect constraints, other

product prices can be adjusted upward based on competitor and customer informa-tion until the total revenue generated is sufficient to cover the costs incurred by TheBakery. Following is a discussion of the rationale behind major categories of prices:

. Beverages—because of high prices charged by competitors, prices for bev-erages were raised to the highest possible value given the constraints. This isconsistent with industry standards, where soft drinks generally receive sig-nificantly higher markups than other food items.

. Cakes, large cookies, and variety bags—prices for these items were raised asmuch above the cost-based prices as possible. This increase was based on thelow price sensitivity of parents, availability of delivery, and high prices ofcompetitors.

. Breakfast baked goods—prices for these items were raised only slightly abovetheir cost-based prices. The only exception was muffins, which had significantlyhigher customer demand, indicating that they were more popular and mighthave lower price elasticity.

. Classic and gourmet cookies—because the cookies were freshly baked, werealready significantly cheaper than the competition, and enjoyed significantpopularity as evidenced by their high demand, their price was raised onlyslightly over the previous price.

. Brownies and Rice Krispy treats—the cost-based prices for these items, as wellas competitor prices for the brownies, suggest that these items were previouslysignificantly under-priced. Therefore, their prices were raised slightly over theprevious price.

The resulting prices are shown in column 8 of Table 3. The appropriateness ofthese prices, given the break-even goals of The Bakery, is proven by examination ofthe Variable Costing Income Statement shown in Table 5.2

6.4. Cost volume profit analysis

Requirement 4 of the case asks students to consider the value of the contributionmargin income statement for predicting income and determining the influence ofchanges in fixed costs on The Bakery’s profitability. The value of the contributionmargin income statement is in the information it provides about cost behavior.Because The Bakery has so many products, CVP must be performed in terms ofsales dollars. Based on the income statement in Table 5, The Bakery has a total of$690 in fixed costs. Its contribution margin ratio is $.7187 per dollar in sales($690.73/$961.10).

2 The pricing analysis described above ignores the effect of future inflation on the appropriateness of

the prices computed. A conscious decision was made by the authors to leave this factor out of the analysis

to simplify the discussion. However, some students do pick up on the importance of inflation. It is not

inappropriate to consider inflation by either applying an inflation factor to the initial cost information or

to the final prices.


Table 8

Price computation worksheet for outsourcing what-if—input sheet

Civil service labor –

Other overhead 40.00 Outsource cost 250%

Student labor 450.00 Increase in demand 25%

Item Materials cost

per unit

Outsource

cost

Original

weekly demand

New weekly

demand

Competitor

price

Previous

price

16 oz Bottled juice $0.60 $1.50 46 58 $1.05 $0.90

Milk 0.15 $0.38 20 25 0.60 0.30

12 oz. Coffee 0.13 $0.33 9 11 0.85 0.40

14 oz. Soft drink 0.08 $0.20 22 28 0.75 0.50

20 oz. Soft drink 0.14 $0.35 33 41 0.85 0.60

33 oz. Soft drink 0.24 $0.60 55 69 1.05 0.90

9�1300 Cake 1.33 $3.33 6 8 14.00 9.00

18�1300 Cake 2.94 $7.35 4 5 20.00 12.00

900 Round cake (2 layer) 2.25 $5.63 3 4 19.00 10.50

Large cookie 0.50 $1.25 4 5 5.00 3.00

Extra large cookie 0.99 $2.48 6 8 8.00 6.00

Classic bag 1.44 $3.60 2 3 3.00

Gourmet bag 1.55 $3.88 3 4 3.50

XYZ-State bag 1.66 $4.15 4 5 4.00

Jumbo cinnamon roll 0.22 $0.55 35 44 1.00 0.75

Regular cinnamon roll 0.09 $0.23 41 51 0.75 0.50

Jumbo pecan roll 0.48 $1.20 21 26 1.25 1.00

Regular pecan roll 0.24 $0.60 25 31 0.85 0.75

Muffin 0.10 $0.25 152 190 0.85 0.40

Turnover 0.12 $0.30 32 40 0.75 0.50

Bagel 0.30 $0.75 40 50 0.85 0.40

Classic cookie 0.05 $0.13 96 120 0.50 0.30

Gourmet cookie 0.11 $0.28 261 326 0.75 0.50

Brownie 0.35 $0.88 68 85 0.95 0.50

Rice Krispie treat 0.35 $0.88 156 195 0.75


Ed.19(2001)283–303

301

Evaluating the scenarios in requirement 5 is fairly straightforward. In a weekwhen sales were $1500, The Bakery would earn an income of $388.05 ($.7187/salesdollar�$1500 sales �$690 fixed costs). Assuming sales at the average weekly levelof $961.10, if the overhead increased to $190, total fixed costs would increase to$840. As a result, The Bakery would either need to increase average weekly salesvolume to $1168.78 ($840/.7187) in order to break even, or they would have main-tain their sales volume, increasing selling prices to earn total sales of $1110.37(Sales�270.37 �840=0). This amounts to a new contribution margin ratio of $.7565per dollar in sales ($840/$1110.37) and a 15.5% increase in prices([$1110.37�$961.10]/$961.10).Two broad assumptions are inherent in these computations. First, one must

assume that behavior of costs and revenues does not change in response to thechanges being analyzed. That is, the predictions are being made within the relevantrange associated with the averages in the income statement. While the student andcivil service labor should remain fixed based on the information in the case, if pre-dictions were for a higher level of sales than $1500, this assumption might well nothold true for civil service labor . Additionally, costs and revenues must behave in atruly linear fashion. For example, The Bakery cannot receive discounts on materialsas quantity used increases nor can the volume of sales be influenced by the sellingprice or vice versa.The second major assumption being made is that the mix of products must remain

constant. Because prices are not strictly based on costs, different products have dif-ferent individual contribution margin ratios. Consequently, a larger increase in salesfor low-contribution margin products relative to increases for high-contributionmargin products will result in a smaller increase in income than anticipated underthe assumption of a constant product mix.

6.5. What-if analysis and outsourcing

The above discussion of CVP is a simple form of what-if analysis. The outsourcingdecision described in Requirement 5 requires a more sophisticated what-if analysisthat is best facilitated by modification of the original spreadsheet. Table 8 shows thenew input sheet, with the outsourced cost (250% of materials), new weekly demand(25% of original weekly demand), and reduced fixed costs (the civil service laborwould no longer be needed if production were outsourced). The computationsworksheet has been changed as follows: (1) the cost basis now refers to the out-sourced cost, rather than the materials cost, and (2) all formulas use the newdemand levels. The loss resulting from the new cost structure applied with the oldprices is shown at the bottom of Column 8 of Table 7. To compute the necessarychange in prices, one simply divides the revenue shortfall of $133.53 by the totalrevenue earned based on the old prices and new volume of $1,201.38 to determinethat an 11% increase in prices is needed.In determining whether The Bakery should outsource their baked goods, a num-

ber of factors might be considered. The influence of this practice on customer per-ceptions of The Bakery would be important. Perceptions could, of course, be


influenced either positively or negatively. The ability of the local bakery to adapt toThe Bakery’s variable sales volume and to deliver good quality bakery items in atimely fashion would also be important. The influence on the civil service laborersmight also be important. The possibility of needing to lay off workers seems lesspressing than the concern that the cost of these workers’ salaries might have to beabsorbed by other areas of housing and dining services.


the bakery a cross-functional case study for introductory managerial accounting

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