Pappadeaux the Current Accounting System at Pappadeaux

Pappadeaux

The current accounting system at Pappadeaux is fundamentally flawed, and the result is distorted performance figures for managers. Appendix A contains the basic income statement that Harry is using to evaluate Gregory, with variance noted. However, Gregory should not be evaluated on matters that do not relate to his performance. A significant portion of the poor performance against the budget relates to elements of the budget that were out of Gregory's control. For example, all food is purchased at head office; overhead is allocated by head office; utility rates cannot be controlled, only usage; Harry granted supervisors a raise; rent is established by corporate head office; taxes are out of Gregory's control.

With respect to food costs, a variance budget would show that the food expense should be 1/3 of sales, based on the budget. This implies that the food budget should have been $266,666 but was $240,000. This is an improvement of $26,666. The supervisors' budget would have been on target if not for Harry granting them a raise. This would have been $80,000. Based on the budget, hourly labor should have been 20% of sales, or $160,000 based on $800k in sales. This was therefore $10,000 under budget. Thus, when all of these factors are taken into consideration, Gregory did $40,667 better than he should have (Appendix B).

It also needs to be taken into consideration that sales only disappointed because the advertising budget was cut 20% nationally and 40% in San Diego. For a new restaurant to only see a sales reduction of 11.1% from the target with a 40% advertising cut is impressive. If anything, Gregory did an exceptional job adapting to the reduced sales. He brought food, supplies and hourly labor costs below expectations. The overages in supervisory labor, rent and corporate overhead were the direct result of head office decisions, and therefore should not reflect on Gregory's performance evaluation. Likewise, Gregory has no control over the taxes the business pays -- in fact the better he does the more taxes the restaurant will pay. The only area where Gregory could perhaps have performed better is with respect to utilities, finding ways to reduce utility usage in the face of higher than expected costs. He could also have fired a supervisor to make up for the increase in supervisor pay that Harry granted.

Responsibility accounting is the key concept here. Gregory's restaurant underperformed largely on the basis of decisions that head office made. When the performance based on Gregory's decisions is used as the basis for evaluation, it becomes clear that Gregory performed very well, exceeding the budget by $40,667 despite adverse circumstances such as trying to launch a restaurant with a 40% cut in advertising revenue. Management simply cannot treat all cost categories the same. Fixed overhead in this case generally comes from head office -- Gregory cannot be measured against changes that they made. He might not even be aware of those allocation changes. The variable costs should be evaluated against the expected performance based on the new sales level. The same percentages should be used in the evaluation. If Gregory comes below those percentages, then he has outperformed expectations. It is not sufficient to simply evaluate variable cost performance based on raw numbers -- percentages must always be used to evaluate variable cost performance. The result of a more accurate and sophisticated analysis process is that Gregory outperformed expectations significantly. While he was expected to generate a net margin of 8.2%, he actually delivered a net margin of 13.25%. If anything, Gregory should get a bonus and a raise, and this situation should result in changes to Pappadeaux's performance evaluation system to use responsibility accounting and other basic accounting concepts more effectively.