Freda is the manager of a busy hotel serving business and leisure customers with a range of conference and leisure facilities.

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1 This question is set in a common service environment - the hospitality sector. As you prepare an answer, think about how the principles of optimising inputs and outputs can be applied to any organisation. Freda is the manager of a busy hotel serving business and leisure customers with a range of conference and leisure facilities. She has asked you to help her understand the hotel s performance better as she keeps missing her monthly profit target. The hotel has a detailed budgeting system, but every week seems to be different depending on the time of year, the weather and local conference activity. Sales and costs vary greatly, and it is difficult to hold departmental manager s accountable. Required: Advise Freda how the principles of standard costing might help her to plan and evaluate the performance of the hotel. Management accounting for services standard costing and hotels Suggested answer plan 1. Introduction Brief outline of standard costing - characteristics/components and purpose. 2. Problem-set of hotels maximising revenue/capacity can t store the product high volume of routine service events plus ad hoc events albeit that these have multiple common inputs and outputs planning set performance standards, behaviours and unit costs/prices need to model capacity, costs and resources how to maintain individual accountability over a 24/7 cycle. 1

2 3. Evaluation establish controllability, monitor revenues and costs by department through monthly and weekly budgets flex budget to actual activity level isolate differences (variances) by factor and then investigate learn for next period, using feedback and feed forward control give example of flexing and variance analysis. Full answer Introduction Standard costing provides a framework for planning and evaluation wherever there are a high number of routine or relatively predictable service events or tasks. It can be as helpful in a wide range of service industries as it is in factories. In the case of hotels, the monthly sales revenue (outputs) and costs (inputs) will be comprised of myriad individual activities. While the management will be keen for staff to see each of these as a unique customer experience, there is a significant level of task commonality and business predictability. Predetermined standards for direct costs (food, consumables and staff labour) can be combined with assumptions about activity levels for use preparing individual customer quotations or the construction of departmental budgets. For example, unit standards can be established for the average cost of food per plate at a lunchtime buffet. The standards may be set at either practical or ideal levels and the choice will have implications for how management use the budget and subsequent variance analysis to motivate, evaluate and reward its managers. The problem set of hotels Hotels have a high volume of routine service events with associated tasks such as providing a clean guest with towels, soap, linen, etc. 2

3 On one hand, service outputs could be said to be intangible, in that customer satisfaction is likely to be a key operating performance measure. On the other hand, a night with a satisfied customer is a very definite output. If we take customer service as a given for now, we have the basis for using standard costs and budgets to control performance. The same applies to understanding how total revenue and average revenue per per night (ARPN) might be better or worse than expected and why. Indeed, as a service business, hotels arguably have a greater need for understanding revenue than many manufacturers in that unsold capacity cannot be held in stock for sale in the next period. Hotels also hold ad hoc events tailored to the requirements of individual customers - for example, weddings and conferences. While there is some variability, ad hoc events will still have a significant proportion of largely predictable unit costs - for example, 200 mid range buffet lunches, hire of one large for the day requiring five staff in attendance, and so on. Unit costs for common inputs/activities, may account for, say, 80% of total costs and thus can be estimated in advance, with out of pocket costs specific to the each individual event, such as evening fireworks, being allocated as they arise. See job costing and cost build up documentation in Seal et al, referenced below. Planning Hotels will usually be most concerned with maximising total contribution to cover substantial fixed overheads. For each planning period, activity, revenues and costs will need to be modelled to produce an optimum outcome, given wider market factors and the promotion budget available. While bookings may fluctuate from day to day, weddings and conferences might be booked months in advance. Once a detailed sales budget has been prepared, other operational departments will compile their own plans. The 3

4 management accountant will then consolidate all the plans and coordinate the iterative process of negotiation with top management, and adjustment with other departments, until an acceptable master budget can be approved - not forgetting that the cash budget must also support the plans. The controllability principle helps us to consider who is responsible for what and how revenues and costs should be attributed to individual departments, apportionment, allocation or some form of transfer pricing. For example, how should the cost of discounting guest beds be treated? This will depend on how prices are set. We should ask to what extent are volume and rates simply a function of market and therefore uncontrollable? Should variances be simply written off to the P&L? Perhaps certain factors are under our control - for example, who decides on offering advance promotional offers and what tradeoffs there might be with the promotion budget? Perhaps the hotel has a guest reward scheme in which free stays can be earned. Conversely, income may be lost through having to make reductions in customer bills (cash credits) to reflect double bookings or poor service. Evaluation After the end of each accounting period, be it a week or month, the original budget needs to be flexed for each account heading to reflect what the original budget would have been if actual activity had been known in advance. Actual revenue or cost can then be compared line-by-line with the flexed budget and the variances calculated. Note that only the variable element will be adjusted. Table 1 shows the result for a hypothetical hotel situation. 4

5 Table 1. City View Hotel - Sales variances for March 2009 Sales Original budget Flexed budget Actual result Room nights 5,000 4,000 per night (ARPN) Variance = 500, , ,000 40,000 Favourable. 100,000 Adverse. - Volume variance Straightaway we can see that there is a significant problem with a shortfall of 1,000 units in activity, resulting in a volume variance representing 100,000 of lost contribution. However, because the ARPN was better than budget ( 110 v. 100), 40,000 of the deficit has been recouped. The management accountant should investigate the potential causes, asking how and why things turned out as they did. For example, perhaps the reservations department decided to put up rates and this resulted in lost bookings. Alternatively, the tourist market might have declined generally and instead reservations staff should be congratulated for managing to increase prices on the business that was still available. Perhaps the hotel benefits from a base of regular income from business travellers which is topped up by more unpredictable tourist income that is the first to disappear in any downturn. This might explain the rise in the ARPN which might otherwise appear counter intuitive. The management accountant has gone further in her investigation by analysing the sales variances by department. Table 2 shows variances against budget for each responsible department (that is, those executives allowed to alter prices or 5

6 give refunds) together with the causal factor. The cost/gain for each department has been split between waivers at standard cost and cash refunds for poor service, double bookings, and so on. The grand total of nights lost ties back to the volume variance of 1,000 nights lost at a cost of 100,000 in Table 1. The table reveals that at the beginning of the month 30 nights were lost due to emergency repairs to staff beds and another 50 nights were lost due to staff from a sister hotel visiting for a training course. Operations management had taken the decision to put staff into guest s as they assumed the hotel was not busy, although marketing had already reacted to this by offering a three-nightsfor-two deal. This opportunity cost (lost revenue) had been overlooked and we should ask whether such things tend to be recurring events and should be budgeted. The table also reveals that the reservations department must have actually increased prices by a further 8,000 (above the 40,000 favourable variance) to compensate for the cash refunds given by themselves ( 1,000) and management ( 7,000). We might ask at this stage how the standard ARPN is set. Is allowance made for cash refunds? Is this month typical? While it might be helpful to make managers aware of the full implications of customer problems, by not adjusting the budget at the planning stage there could be unanticipated cash flow issues. 6

7 Table 2. Variances by responsibility and cause. R E S P O N S I B I L I T Y Marketing (promotion) Reservations CAUSAL FACTOR Advance bookings Refunds On the night -400rn -50rn ( - 5k nights). Nil cash - 40k Nil cash -60rn - 6k - 1k cash -360rn - 36k + 48k price Total -450rn - 45krn Nil cash -420rn - 42k + 47k price Operations 80rn - 8k Nil cash -50rn - 5k - 7k cash -130rn - 13k - 7k cash Total -480rn - 48k Nil cash -160rn - 16k - 8k cash -360rn - 36k + 48k price -1,000rn - 100k + 40k price Digging down into further detail, we might uncover that there was a change in the mix of s occupied with executive s achieving, say, 90% rather than the planned 70% of capacity level, while standard capacity fell from 85% to 70% (due to a major travel operator not renewing their contract because they were offered better prices elsewhere). The possibilities are endless and analysis of the cost side variances might also reveal interrelationships with sales variances. For example, a saving on cleaning labour may have meant that late checkout facilities were not available and consequently some bookings were lost. 7

8 Further insights might be gleaned through analysis of performance metrics. For example, key performance indicators such as client satisfaction might have lower scores this month and that has affected sales revenue. In the longer term product innovations, such as the number of menu changes per season, might have played a part, too. In summary, to align with stakeholder s need for stewardship and economic returns, a hotel like any other business needs to understand its financial performance in terms of what it set out to do and what it actually achieved. This is the role of budgeting and standard costing. Financial and non-financial measures can be complementary to the standard costing scheme, but we need to use variance analysis as a framework to understand the ups and downs of departmental performance as it feeds into the overall profit and loss account. Further reading: Seal, WB, Garrison and Noreen (2009) Management Accounting European Edition, 3 rd ed. McGraw Hill. 8