Case

The Bakery:
a cross-functional case study for introductory
managerial accounting

Stacy E. Kovar
a,
*, Kristin Evans
b
a
Department of Accounting, Calvin 109, Kansas State University, Manhattan, KS 66503,USA
b
Cessna 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 on
accounting data, (2) to give students practice in pricing, cost volume prot analysis (CVP) and
outsourcing 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 introductory
accounting students. The Bakery is a non-prot organization whose primary function is to sell
baked 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 product
oerings, prices, and accompanying services, and their own knowledge of The Bakerys 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 Bakerys
operations. # 2002 Elsevier Science Ltd. All rights reserved.
Keywords: Pricing; Managerial accounting; Cost volume prot analysis; Outsourcing; What-if analysis
J. of Acc. Ed. 19 (2001) 283303
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
nancial 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: skovar@ksu.edu (S.E. Kovar).
1. Background
The Bakery, a retail bakeshop located within housing and dining services of XYZ
State University, rst opened in 1990. The business was established by the campus-
wide, non-prot housing and dining service to provide baked goods, including
breakfast and dessert items, to students who live in the residence halls. Hotel and res-
taurant management students originally operated The Bakery. These students were in
charge of the selling and management functions of the operation, but civil service
employees produced the baked goods. The only exception to these procedures was
that 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 are
shown in Table 1.
2. A new nancial manager
You have been brought in as the new nancial manager of The Bakery. After
talking with your supervisor, Mr. Smith, you decide that the pricing of the products
needs to be reevaluated and updated. Mr. Smith is concerned that some product
prices 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 is
a priority to The Bakery because of its mission of serving students. You and Mr.
Smith agree that relative prices for dierent products should be based on direct
materials cost only, because other costs of manufacturing individual products (such
as labor and overhead) would be dicult to determine. You also agree that other
factors 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 to
serve the students and not to generate a prot. I feel that a student should not have
to 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, and
variety bags, which contain several items packaged in a decorative container. In
addition, I am afraid if you raise the price of any item more than 25%, students will
become upset and may stop coming to The Bakery. Finally, for ease of use, all prices
should 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 best
to rst determine the direct materials cost for each product sold by the Bakery. This
information has been gathered and is provided in Table 2.
284 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
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 is
available at all hours when the store is open. There is not enough space in the store
for more than one person to work. Overhead consists of the costs of maintaining the
area where The Bakery is located (maintenance includes large items like painting
and replacing countertops), The Bakerys share of utilities, janitorial, and other
services. These costs, amounting to about $40 per week, are determined based on a
formula, but Mr. Smith indicates that he expects them to remain fairly constant as
long as the size of The Bakery does not change. The cost of salaries for the civil
service employees who prepare the baked goods is categorized as direct labor. While
it might be possible to change these costs in the long run, Mr. Smith estimates that
they will remain constant at $200 per week as long as total revenues are in a normal
range, which is from about $8001500.
3.2. Competition
After thinking about the costs for The Bakery, you turn your thoughts to The
Bakerys competitors. You should identify competitors for the Bakery, given the
Table 1
Original prices
Menu item Price
16 oz. Bottled juice $0.90
Milk $0.30
12 oz. Coee $0.40
14 oz. Soft drink $0.50
20 oz. Soft drink $0.60
33 oz. Soft drink $0.90
913
00
cake $9.00
1813
00
cake $12.00
9
00
Round cake (2 layer) $10.50
Large cookie $3.00
Extra large cookie $6.00
Classic bag
a
$3.00
Gourmet bag
a
$3.50
XYZ-State bag
a
$4.00
Jumbo cinnamon roll $0.75
Regular cinnamon roll $0.50
Jumbo pecan roll $1.00
Regular pecan roll $0.75
Mun $0.40
Turnover $0.50
Bagel $0.40
Classic cookie $0.30
Gourmet cookie $0.50
Brownie $0.50
Rice 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) 283303 285
nature of its customers and products oered. Once identied, you should visit and
evaluate these competitors to determine how the products and services they oer will
inuence the prices for The Bakerys products.
4. Customers and demand
Most items at The Bakery are purchased by students. The average student at XYZ
State 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 itemscakes, large cookies, and
variety bags (Classic, Gourmet, and XYZ-State bags)are primarily bought over
the 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. Coee $0.13 9
l4 oz.Soft drink $0.08 22
20 oz.Soft drink $0.14 33
33 oz. Soft drink $0.24 55
913
00
Cake $1.33 6
1813
00
Cake $2.94 4
9
00
Round cake (2 layer) $2.25 3
Large cookie $0.50 4
Extra large cookie $0.99 6
Classic bag
a
$1.44 2
Gourmet bag
a
$1.55 3
XYZ-State bag
a
$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
Mun $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
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.
286 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
5. Requirements
1. Before beginning the assignment, think about how costs, constraints, compe-
tition, and customer characteristics should inuence the prices of The Bakerys
products and, consequently, how you should go about determining the prices.
Be explicit for each item. Consider The Bakerys objective of fair pricing, as
indicated by Mr. Smith, as well as the organizations non-prot status.
2. After you have completed requirement 1, create a spreadsheet to collect/com-
pute necessary information to help in setting prices. Your spreadsheet should
be 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 the
eect of these changes on cost-based prices and income. To accomplish this,
the spreadsheet should have four individual worksheets.
(a) The rst worksheet, the input sheet, should be where all of the given infor-
mation is entered - previous prices, costs, weekly demand, xed costs for labor
and 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 any
constraint-related values. In addition to other necessary columns to show
computations clearly and neatly, the computations worksheet should have a
column showing the maximum price for each of the products based on the
various constraints identied by you and Mr. Smith. The last column in the
computations worksheet should allow the user to judgmentally select and enter
the new menu price for each item by looking at information provided in the
worksheet as well as other factors he or she wants to consider. At the bottom
of the column, the total revenue, total cost, and net income resulting from the
nal prices should be shown so that the user can see the eect 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
(A1B1+A2B2+A3B3). 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 to
round 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 result
will be 554.25. This function is useful for rounding the prices to 5-cent
increments as required by Mr. Smith.
S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303 287
(c) The nal worksheets, the output worksheets, should present the price list
and a contribution margin income statement in clearly readable form. The user
should 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 the
rst two worksheets.
3. Once you have completed your spreadsheet, use it as well as other information
about customers and competition to arrive at prices for the products. Prepare a
report for Mr. Smith describing how your spreadsheet works and the steps you
used for setting prices, including a description of the role of costs, constraints,
competition, and customers in motivating your decisions. Your report should
not 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 worksheets
and is impressed. Mr. Smith was intrigued by the variable costing income
statement you showed him. He has never seen an income statement where costs
were divided into variable and xed categories and thinks this might have some
potential. He has asked you for recommendations for using this information.
You remember an earlier conversation with Mr. Smith where he indicated
that The Bakerys weekly sales are actually very erratic, depending not only on
whether the semester is in session, but also on the time of the semester, with sales
being much higher during times such as nals week. Mr. Smith was complaining at
the time that, while he can usually predict total sales for any given week based on
past experience, this variability makes it tedious estimating the income/loss for
The Bakery each week as required by housing and dining services. You also recall
that Mr. Smith had once been very concerned when housing and dining services
was going to dramatically increase the cost of overhead charged to The Bakery.
He spent some time in his oce computing the eect 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 from
your average weekly income statement to (1) develop a model and quickly
predict income for any given week when an estimate of total sales is known,
and (2) identify the eect of changes in factors such as total overhead cost on
The Bakerys protability. Bear in mind that Mr. Smith will not want to have
to estimate total sales of each individual item to make predictions. Describe the
assumptions that would have to be made for the model to result in accurate
predictions. As you describe your model, include examples for Mr. Smith
where you predict the income for a week where total sales are expected to be
$1500 and evaluate the eect 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 eect of a possible change in the Bakerys operations that he has been
considering. This change would involve having Java, a local bakery and coee
house, 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 products
would increase by 25% if the baked goods were purchased instead of
288 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
produced. Java would charge The Bakery 250% of the materials cost (materi-
als costs are shown in Table 2) for the completed baked goods. Outsourcing
the production of The Bakery items would not inuence the amount of general
overhead applied to The Bakery.
Mr. Smith would like to know what eect this outsourcing decision would
have on the prices that The Bakery must charge. Would the prices have to be
increased, 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, what
would the percent be? What other, possibly non-quantitative, factors should be
considered when making the decision? Include with your answers copies of
your 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 for
introductory 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 income
statement, to use the income statement for cost volume prot analysis (CVP), and to
perform what-if analysis for an outsourcing decision. The case requires students to
consider accounting information in the context of marketing and economics-related
information. 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 of
structuring a spreadsheet with separate data entry, computation, and output work-
sheets, which facilitate what-if analysis, and by giving them experience in using the
spreadsheet 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 on
a 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 partsa portion dealing with setting prices (case require-
ments 1-3), another part addressing CVP analysis (requirement 4), and a third part
requiring 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 the
other two parts, both the CVP and outsourcing/what-if aspects of the project are
optional. An obvious time for assigning this case is while covering chapters where
cost behavior and pricing and outsourcing decisions are discussed. Another possible
time 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 well
as the usefulness of a variable costing income statement for making projections.
S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303 289
This case is best completed in groups of threefour students because students can
easily divide responsibilities for checking competitors prices and products, com-
puting cost-based prices, writing the report, and performing the what-if analyses
described in the last requirement, thus reducing the total time devoted to the case.
However, students must ultimately work together to arrive at a nal set of prices,
articulate the tradeos that guided their decision process, and communicate the
CVP and outsourcing results, which helps to lessen the risk of unequal participation
and 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 procedure
discussed in this solution. Students must also read the case, answer the questions in
requirement No. 1, and assess (1) what tasks will be necessary to complete the case
and (2) how these tasks could be divided among the students in their group. During
the next class period, the practice problems are briey discussed and students are
given time (20 minutes) in class to coordinate with their group. Students are
instructed that they should plan to spend approximately three additional hours
working on the case and two additional hours meeting with their group. The next
topics 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 the
due date of the case. Additional group meeting times can be provided either in or
outside of class. In-class meetings help alleviate schedule conicts and encourage
equal 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, I
rst draw a table on the board or on a transparency with column headings for each
of the four general factors considered in setting pricescosts, constraints, competi-
tion, and customers. Drawing attention to the cost column, I present the markup
and cost-based price computation in the rst three columns of the solution shown in
Table 3, on a separate transparency or by actually projecting the spreadsheet,
depending on the technology available. Students generally are able to arrive at the
correct computation with little assistance. At this point, I draw attention to the
structure of the spreadsheet, with separate columns for input and computations,
noting that none of the cells on the computations sheet (not even the descriptions of
the products) actually contain raw data, but instead refer to data on the input sheet
shown 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 of
this solution. Once these are listed on the board, I display columns 47 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 students
state their factors, the audience classies the points addressed by that group as
related to cost, customers, competitors or constraints. Once all of the presentations
are complete, the grid on the board can be reviewed and the class and instructor can
complete the grid by adding any considerations not mentioned. This board plan
290 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
Table 3
Price computation worksheetscomputations sheet
1 2 3 4 5 8 7 8
Item Cost basis Markup % Unit
Costmarkup
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. Coee $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
913
00
Cake $1.33 355% $4.72 $11.25 $14.00 $11.25 $11.00
1813
00
Cake $2.94 355% $10.44 $15.00 $20.00 $15.00 $15.00
9
00
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
Mun $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)
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Table 3 (continued)
1 2 3 4 5 8 7 8
Item Cost basis Markup % Unit
Costmarkup
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%
2
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helps to emphasize that all four general factors must be considered and to also bring
out the fact that some considerations jointly relate to more than one category. For
example, factoring in the distance required to travel to a potential competitors place
of business considers both the characteristics of the customer (does not want to
travel far) and the competitor (what level of convenience do they oer). Finally, I
display the nal 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 CVP
analysis is reasonably straightforward, so I focus on discussion of the assumptions.
In addressing the outsourcing scenario, I try to spend time polling students asking
them what types of modications they had to make to their spreadsheet in order to
evaluate the scenario. Generally, students have made more signicant modications
than would have been necessary had they anticipated what-if analysis in advance
and 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 worksheetinput 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. Coee 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
913
00
Cake 1.33 6 14.00 9.00
1813
00
Cake 2.94 4 20.00 12.00
9
00
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
Mun 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
S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303 293
Many dierent solutions are possible for this case depending on the competitive
environment and student characteristics at the particular school. Supporting com-
putations for one possible solution to the case are presented in Tables 3 and 4 (Input
and Price computation worksheets), Table 5 (Variable costing income statement),
Table 6 (New price listing), and Tables 7 and 8 (Input and Price computation
worksheets for outsourcing what-if). The solution presented below addresses the
pricing, 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-
tionscosts, constraints, customers, and competition.
6.3.1. Costs
The steps for computing prices based on a markup over cost are as follows:
1. determine total budgeted cost for the business;
2. determine desired prot and revenue;
3. determine which costs will be associated with individual items;
4. determine the markup percentage; and
5. determine prices based on cost and the markup percentage.
To compute total cost for The Bakery, one must rst compute total materials cost
for each item using the data in Table 2. Then, xed costs for student labor, over-
head, and civil service labor are added to the result to get total cost. Instead of
creating a separate spreadsheet column for total cost, the spreadsheet shown in
Table 3 uses the sumproduct(CostBasisColumn, WeeklyDemandColumn) function in
Excel to multiply the basis shown in column 1 of Table 3 (the cost basis is the
materials cost per unit from the input worksheet in Table 4) by the average weekly
demand quantities which have been entered on the input worksheet in Table 4. This
saves space in the worksheet and makes it a bit easier to follow.
Once total budgeted cost is determined, the desired prot and corresponding rev-
enue should be computed. For The Bakery, total prot should be zero. Thus, the
total revenue for The Bakery should be the same as the total cost in Table 3, $960.37
per 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
294 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
materials cost per unit, as stated in the case description. The markup percentage is
calculated as follows:
Markup=total revenue/total materials cost=$960.37 / 270.37=355%
The prices for all products on The Bakerys menu, computed using this markup,
are shown in column 3 of Table 3.
6.3.2. Alternative methods for computing initial prices
After demonstrating these computations, I ask students if anyone used a dierent
method for computing prices. Upon seeing some of the unrealistic prices resulting
from setting prices based on materials cost, each semester at least one group decides
to set prices using a percentage increase over the previous price.
I use this opportunity to discuss the inherent dierences between cost-based and
market-based pricing. Using a at price increase emphasizes the importance of
market-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. Smiths
emphasis.
Table 6
New price listing
Menu item Price
16 oz. Bottled Juice $1.00
Milk $0.40
12 oz. Coee $0.50
14 oz. Soft drink $0.60
20 oz. Soft drink $0.75
33 oz. Soft drink $1.00
9x13
00
Cake $11.00
1813
00
Cake $15.00
9
00
Round cake (2 layer) $13.00
Large cookie $3.75
Extra large cookie $7.50
Classic bag
a
$3.75
Gourmet bag
a
$4.40
XYZ-State bag
a
$5.00
Jumbo cinnamon roll $0.80
Regular cinnamon roll $0.50
Jumbo pecan roll $1.00
Regular pecan roll $0.75
Mun $0.50
Turnover $0.60
Bagel $0.50
Classic cookie $0.30
Gourmet cookie $0.50
Brownie $0.60
Rice Krispie Treat $0.90
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) 283303 295
Table 7
Price computation worksheet for outsourcing what-if computations sheet
1 2 3 4 5 6 7 8
Item Cost basis *Markup % Unit
costmarkup
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. Coee $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
913
00
Cake $3.33 158% $5.25 $11.25 $14.00 $11.25 $11.00
1813
00
Cake $7.35 158% $11.61 $15.00 $20.00 $15.00 $15.00
9
00
Round 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
Mun $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)
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Table 7 (continued)
1 2 3 4 5 6 7 8
Item Cost basis *Markup % Unit
costmarkup
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 xed 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%
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6.3.3. Constraints
When reviewing students lists of constraint-related pricing factors, I emphasize
that the constraints in this case result from organizational policies established by
Mr. Smith that enforce the mission and values of the organizationto provide fairly
priced, aordable 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 maximum
price 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, found
in 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:
mround min column4; column5; column6 ; :05
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 constraint
values from columns 46.
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 not
very realistic when common prices for these items are considered. For example, the
cost-based price of a bottle of Minute Maid juice turns out to be $2.13 while this
item generally sells for $1.00$1.50 in competing stores. On the other end of the
spectrum, the cost-based price for a mun is $.36 while the least expensive selling
price in competing stores is $.85. Therefore, a systematic evaluation of The Bakerys
competitors and customers is needed both to serve as a basis for deciding which
product prices can reasonably be raised and to adjust prices to realistic levels, where
appropriate.
1
6.3.4. Competition
I 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 is
largely determined by their price elasticity of demand, dened as the percentage
change 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 specically 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.
298 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
elasticity exists when competitors oer viable substitutes. Marketing theory suggests
product characteristics that might be important in evaluating whether a competitors
product 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 the
baked goods oered by competitors (a bakery and a convenience store oer very
dierent products), how easy the competitor is to access (especially on a residential
campus), the availability of products comparable to the items oered by The Bakery
(especially the variety bags), and the availability of delivery for cakes and large
cookies which may be purchased by parents from another city. At XYZ state, the
only easily accessible competitor to oer a product of similar quality to The Bakery
at a comparable price is the student union. The student union does not carry large
cakes, cookies or variety bags. While the local grocery store has a bakery oering
cakes and large cookies, they do not provide delivery service, which reduces but does
not eliminate their viability as a competitor. Consequently, column 6 of Table 3
shows the student unions prices for the single-serve items and the grocery store
bakerys prices for large cookies and cakes. These prices, along with customer
information, will be used as a basis for evaluating the reasonableness of the initial
prices and making adjustments.
6.3.5. Customers
The economic concept of price elasticity of demand can also be used to model how
customer characteristics may inuence decisions about pricing. Four important fac-
tors discussed in the marketing literature may inuence customers willingness to
change buying patterns and therefore their elasticity:
1. the customers degree of need for the product;
2. the customers perceptions of quality, status, or uniqueness for the product;
3. the attractiveness of accompanying services, given the customers needs; and
4. the customers ability to pay.
In terms of the above four characteristics, students, who probably have a meal
plan through the dormitory cafeteria to provide for most of their needs, demonstrate
a moderate degree of need for the product. However, because snack items like those
from The Bakery often represent a spontaneous purchase, perceived need may be
high at the time of purchase. The Bakerys products do oer a change of pace from
dormitory food, therefore most students would consider them of relatively high
quality, particularly the fresh-baked cookies. Accompanying services are unim-
portant for the single-serve items purchased by students. Finally, many students
often have a fairly low ability to pay. As a result, students are assessed as having
moderate 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 a
birthday or other special event and can pay a higher price for this convenience. As a
result, parents are expected to have a low degree of price elasticity.
S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303 299
6.3.6. Setting the nal prices
Once prices have been adjusted downward as needed to reect constraints, other
product prices can be adjusted upward based on competitor and customer informa-
tion until the total revenue generated is sucient to cover the costs incurred by The
Bakery. Following is a discussion of the rationale behind major categories of prices:
. Beveragesbecause of high prices charged by competitors, prices for bev-
erages were raised to the highest possible value given the constraints. This is
consistent with industry standards, where soft drinks generally receive sig-
nicantly higher markups than other food items.
. Cakes, large cookies, and variety bagsprices for these items were raised as
much above the cost-based prices as possible. This increase was based on the
low price sensitivity of parents, availability of delivery, and high prices of
competitors.
. Breakfast baked goodsprices for these items were raised only slightly above
their cost-based prices. The only exception was muns, which had signicantly
higher customer demand, indicating that they were more popular and might
have lower price elasticity.
. Classic and gourmet cookiesbecause the cookies were freshly baked, were
already signicantly cheaper than the competition, and enjoyed signicant
popularity as evidenced by their high demand, their price was raised only
slightly over the previous price.
. Brownies and Rice Krispy treatsthe cost-based prices for these items, as well
as competitor prices for the brownies, suggest that these items were previously
signicantly under-priced. Therefore, their prices were raised slightly over the
previous price.
The resulting prices are shown in column 8 of Table 3. The appropriateness of
these prices, given the break-even goals of The Bakery, is proven by examination of
the Variable Costing Income Statement shown in Table 5.
2
6.4. Cost volume prot analysis
Requirement 4 of the case asks students to consider the value of the contribution
margin income statement for predicting income and determining the inuence of
changes in xed costs on The Bakerys protability. The value of the contribution
margin income statement is in the information it provides about cost behavior.
Because The Bakery has so many products, CVP must be performed in terms of
sales dollars. Based on the income statement in Table 5, The Bakery has a total of
$690 in xed costs. Its contribution margin ratio is $.7187 per dollar in sales
($690.73/$961.10).
2
The pricing analysis described above ignores the eect of future ination 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 ination. It is not
inappropriate to consider ination by either applying an ination factor to the initial cost information or
to the nal prices.
300 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
Table 8
Price computation worksheet for outsourcing what-ifinput 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. Coee 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
913
00
Cake 1.33 $3.33 6 8 14.00 9.00
1813
00
Cake 2.94 $7.35 4 5 20.00 12.00
9
00
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
Mun 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
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Evaluating the scenarios in requirement 5 is fairly straightforward. In a week
when sales were $1500, The Bakery would earn an income of $388.05 ($.7187/sales
dollar$1500 sales $690 xed costs). Assuming sales at the average weekly level
of $961.10, if the overhead increased to $190, total xed costs would increase to
$840. As a result, The Bakery would either need to increase average weekly sales
volume 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
(Sales270.37 840=0). This amounts to a new contribution margin ratio of $.7565
per 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 the
changes being analyzed. That is, the predictions are being made within the relevant
range associated with the averages in the income statement. While the student and
civil service labor should remain xed based on the information in the case, if pre-
dictions were for a higher level of sales than $1500, this assumption might well not
hold true for civil service labor . Additionally, costs and revenues must behave in a
truly linear fashion. For example, The Bakery cannot receive discounts on materials
as quantity used increases nor can the volume of sales be inuenced by the selling
price 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, dierent products have dif-
ferent individual contribution margin ratios. Consequently, a larger increase in sales
for low-contribution margin products relative to increases for high-contribution
margin products will result in a smaller increase in income than anticipated under
the 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 outsourcing
decision described in Requirement 5 requires a more sophisticated what-if analysis
that is best facilitated by modication of the original spreadsheet. Table 8 shows the
new input sheet, with the outsourced cost (250% of materials), new weekly demand
(25% of original weekly demand), and reduced xed costs (the civil service labor
would no longer be needed if production were outsourced). The computations
worksheet 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 new
demand levels. The loss resulting from the new cost structure applied with the old
prices is shown at the bottom of Column 8 of Table 7. To compute the necessary
change in prices, one simply divides the revenue shortfall of $133.53 by the total
revenue earned based on the old prices and new volume of $1,201.38 to determine
that 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 inuence of this practice on customer per-
ceptions of The Bakery would be important. Perceptions could, of course, be
302 S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303
inuenced either positively or negatively. The ability of the local bakery to adapt to
The Bakerys variable sales volume and to deliver good quality bakery items in a
timely fashion would also be important. The inuence on the civil service laborers
might also be important. The possibility of needing to lay o workers seems less
pressing than the concern that the cost of these workers salaries might have to be
absorbed by other areas of housing and dining services.
S.E. Kovar, K. Evans / J. of Acc. Ed. 19 (2001) 283303 303