OPERATIONAL CASE STUDY AUGUST 2016 EXAM ANSWERS Variant 2 The August 2016 exam can be viewed at https://connect.cimaglobal.com/resources/operational-case-study-exam/august-2016- operational-case-study-exam---variant-2 SECTION 1 GUEST PROFITABILITY Comparison of guest profitability and implications: The different levels of profitability per night are because each guest has generated different costs over the course of their stay as a result of the number of hotel activities that they have triggered. Looking at the specific hotel activities listed in the report: Each guest required one check in. For the guest staying for one night the cost generated will be fully reflected in the profit per night figure. For guest B who stayed six nights only 1/6 th of this cost will be reflected in the profit per night figure. For guest A staying 14 nights only 1/14 th of the cost affects the profit per night figure. Hence this will have contributed to guest A having the highest profit per night and guest C the lowest. It is hotel policy that towels are changed when requested by guests (rather than automatically changed daily). It would appear from the data that guests A and B each had six changes of towels which meant that there were six laundry services incurred, effectively the same cost for both guests. However because guest A stayed for 14 nights this cost will be spread over these 14 nights rather than the six nights for guest B. This will have increased the profitability of guest A compared to guest B. We will obviously only need to replenish complimentary items in the room where the guest uses the item in the first place. From the data we can see that guest B used up 20 items, compared to guest A that stayed for longer and only used seven items. Each time an item is replenished it costs our hotel money, therefore the greater the The Chartered Institute of Management Accountants 2016 no reproduction without prior consent
number of items replenished the higher our cost and therefore the lower the profit per night of the guest. Would ABC be beneficial to our business? A key benefit of an ABC system is that it provides more meaningful cost information because it recognises that costs are driven not necessarily by the number of nights that a guest stays but by the decisions that a guest makes (for example the number of complimentary items they use). By using the guest data to establish the costs that are generated it might be possible to alter pricing policy so that for example a guest staying more than three or four nights would obtain a discount on the room rate (on the basis that they generate less costs). This in turn could attract more, long-term guests as they might feel that they were getting a good bargain. Analysing cost information with regard to activities generating the cost might also allow us to be able to better control our costs. By understanding how many times an activity is undertaken, it might be that we can identify ways in which the number of activities can be reduced (for example, by understanding the cost of a check in or check out we might be able to change procedures to reduce this cost). However, there are also potential issues if we were to implement ABC as a costing system: not least the time involved and the potential cost of setting it up and then monitoring activity usage. It is possible that the benefits of ABC will not outweigh these costs. In addition, there is going to be no set pattern to how guests use each activity. From the consultant s report we can see that a guest staying for 14 days only used seven complimentary items, yet a guest staying for half that time used 20. Each guest is an individual and will make their own decisions regarding usage of items and towel renewal, which makes it very difficult to establish a standard level of activity for a particular type of guest. NEW IT SYSTEMS Supply side benefits: One of the key elements in our supply chain is the local food producers and suppliers. Information technology will enable us to capture data on guests with regard to their opinions on our catering facilities, which in turn will enable us to focus attention on areas that we might need to improve. If, for example, guests complain about the quality of the ingredients used in our food then we could if we wish make changes within our upstream supply chain and raise the level of customer value within our business and in so doing improve our competitive position. Information Technology will facilitate e-procurement, which is the key activity of upstream supply chain management, within our business. E-procurement comprises three stages, these being e-sourcing, e-purchasing and e-payment. We can benefit under each of these stages of e-procurement as follows: E-sourcing: We could issue electronic invitations to tender and requests for quotations from our food suppliers which will reduce our purchasing costs; August 2016 2 Operational Case Study Exam
E-purchasing: We could create recurring requisitions and shopping lists for regularly purchased items. These standard lists will form the basis of regular orders which can be amended for each specific order that we place with our chosen suppliers. This will reduce the time taken to create purchase orders and result in a further reduction of our purchasing costs. E-payment: We would have the capability to receive invoices and make payments to our suppliers electronically. This would make payment processes more efficient not only for us but also our suppliers, and would result in a reduction of costs for both parties. Customer side benefits: Information Technology enables the gathering of information. So for example, customer relationship management software can be used to determine the needs of guests, booking patterns, and individual preferences. By the same token we can communicate with guests in order to try and trigger repeat bookings. The new IT system might enable us to cope with any excess demand at any of our hotels. For example, if one of our hotels is at full capacity on any given date the system might be able to offer alternative accommodation within one or more of our other hotels on that date thereby reducing lost bookings. August 2016 3 Operational Case Study Exam
SECTION 2 FORECASTING Factors that should be considered the preparation of a sales forecast for our hotels include the following. Seasonality: Information will be available in respect of previous years and can be used to give us a much better understanding of the sales revenue patterns that might be generated in future periods. Past sales information can be analysed in order to identify any seasonal variations. Reservation mix: The mix of reservations between first time guests and repeat guests will also assist us in our prediction of potential revenue patterns within our hotels. In this respect it useful to look at the extent to which we were successful in converting the enquiries received from both existing and new guest enquiries into hotel bookings during previous periods. Special events: It is probable that revenues will increase when there are special events held close to a hotel s location. Hotel 3 is based in a theatre district and if a particularly popular play is scheduled then it will impact on the demand for the rooms within our hotels. Competition: It is important to retain the history of our closest competitor s room availability and rates per room charged at different times throughout the previous budget period. This information is an important part of the understanding of future demand patterns within our hotels. It would be useful to give consideration to changes in their selling price strategies at different times throughout the previous budget period and to assess the impact on the demand for rooms within our hotels. It would be helpful to compare their selling prices during the forecast period with the prices they charged during the corresponding period of the previous budget year. Advertising: We should give detailed consideration to the level and timing of anticipated advertising expenditure during the forthcoming budget year as this can impact upon the demand for rooms within our hotels. In this regard it would be useful to look at previous advertising campaigns we have undertaken in order to assess the degree of correlation between advertising expenditure and demand for rooms within our hotels. Economic environment: We should consider the forecast economic conditions within Macland which could impact the demand for our rooms. For example a recession within Macland would be likely to cause a downturn in the demand for hotel rooms from leisure guests who might wish to conserve their disposable income. Similarly, a recession could result in reduced demand from business guests. Conversely a boom economy leads to increased consumer spending and may result in an increase in demand for our hotel rooms. August 2016 4 Operational Case Study Exam
BEVERAGE INVENTORY MANAGMENT The nature of the costs associated with our bar inventory: Ordering costs will include the fixed delivery fee that we pay each time the supplier delivers an order to us as well as the cost of the time taken to administer the order by hotel staff. Holding costs will include the costs of storing the beverages in terms of the energy consumed to hold them in a temperature controlled environment and a share of the insurance cost. It will also include the cost of any beverage inventory that we throw away as a result of going beyond its best before date and the cost of the working capital funds that are tied up in the value of inventory. There are also other costs associated with our bar inventory such as lost sales where a particular beverage is not available and lost discounts if we do not purchase in bulk. Appropriateness of EOQ: The EOQ model in principle is useful because it can determine an order quantity that minimises the total of holding and ordering costs. Discounts can also be factored into the calculations to see if it is worth taking them. The problem for us though is that it would be very difficult to apply the model as we hold many different lines of inventory, each with different levels of demand. In addition the EOQ model assumes that demand for the product over the period is constant, which is an unrealistic assumption. Demand at our bars is dependent upon a number of factors such as the number of guests at the hotel (the occupancy), whether there is a function on and whether there are special events happening outside the hotel which take our guests away. Therefore demand is not constant. The EOQ also ignores shortage costs, which are potentially quite significant for our business. If we consistently have beverages which are not available, this means lost sales as well as creating a bad guest impression. Whist EOQ does consider the ordering and holding costs of inventory, it assumes the holding costs can be established per unit of inventory. Thus it assumes that holding costs are essentially variable in nature. In our situation this is not necessarily the case. Irrespective of the level of inventory on hand we are likely to incur the same amount of energy costs as we have to ensure that the shortage area is at the appropriate temperature anyway. Similarly our insurance costs are fixed. Therefore it is unrealistic to establish a holding cost per unit. To conclude, in practical terms EOQ is not likely to be very helpful in respect of managing inventory levels in the bars. The nature of demand means that the Head of Bar and Restaurant is the still the best person to procure inventory (in terms of quantity and frequency) as they will be able to best anticipate peaks in demand from the expected occupancy levels and known function. However, perhaps more guidance needs to be given regarding accepting discounts and a new delivery charge negotiated with our suppliers so that smaller orders are not penalised. August 2016 5 Operational Case Study Exam
SECTION 3 QUALITY COSTS Designing the meals to be included on the restaurant menus: This is a prevention cost as it represents the cost of an action taken to reduce defects and failures of quality. It is possible to reduce perishable food purchasing costs through better menu design. Many restaurants offer standard meals with set vegetables that some customers may not always want. Re-making meals that have been returned by guests: This is an external failure cost as it represents a cost arising from inadequate quality discovered after the transfer of ownership to the restaurant customer. The meal that has to be re-made means that the original meal has to be scrapped and extra ingredients, energy and staff time used to re-make it. The returned meal represents evidence of customer dissatisfaction that can also result in lost customer goodwill. Maintenance of the kitchen ovens: This is a prevention cost as it represents a cost incurred prior to or during production in order to prevent sub-standard meals from being produced. Prevention costs are discretionary costs which would be incurred with the intention of eliminating the costs of internal and external failure within our restaurants. Repairing kitchen equipment that has broken down: This is an internal failure costs as it represents a cost arising from inadequate quality which is identified before any meals have been transferred to the customer. Internal failure costs are costs of non-conformance which can only be reduced by increasing the costs of conformance. Inspecting of incoming products from suppliers: This is an appraisal cost as it represents costs incurred in order to ensure that the ingredients used in the meals that will be produced meet the required quality standards. Appraisal costs are discretionary costs which would be incurred with the intention of eliminating the costs of internal and external failure within our restaurants. Giving complimentary meal vouchers in respect of customer complaints: This is an external failure cost as it represents a cost arising from inadequate quality discovered after the transfer of ownership of the meal to the customer. A complimentary meal voucher given to a guest represents acknowledgement of poor service (either in terms of the meal or service). This will entitle the guest to effectively a free meal; it is the cost of creating and serving this free meal which is the external failure cost. August 2016 6 Operational Case Study Exam
BRIEFING PAPER ON ACCOUNTING FOR IT SYSTEM COSTS Computer terminals and printers (hardware): The computer terminals and printers are tangible assets that will be capitalised as part of property, plant and equipment (PPE) in accordance with IAS 16 Property, Plant and Equipment. We can classify them as PPE because they will be used to generate economic benefit for our business for a period of more than 12 months and the cost can be reliably measured because it is the purchase cost. We will need to depreciate these assets over a period of four years (which is their useful economic life), with a full year s charge in the year of acquisition. Server equipment: The server equipment is also a tangible asset which is to be classified as PPE in the same way as the hardware. It will need to be depreciated over its useful economic life which is still to be established. The one complication with the server is that we will need to pay for it in T$ as it will be coming from Tacland. The asset will be capitalised at its cost of T$58,000 converted into M$ on the date of the purchase. If the payment for the purchase is delayed then an exchange difference might arise on the settlement of the transactions which will affect profit. The recorded cost of the asset, in the statement of financial position, will not change though. Software licences: Because the software licences are for a period of three years we will be able to capitalise the cost as an intangible asset in accordance with IAS 38 Intangible Assets. The licences give us the contractual right to use the software and to generate economic benefit. It is a purchased intangible asset which means that it can be capitalised. The asset will need to be amortised over the three year life of the licence. Fee to IT Solutions: The fee to IT Solutions needs to be split into two. The element that relates to training staff cannot be capitalised as it does not meet the definition of an asset. Whilst the fact that the staff are trained to use the system potentially generates economic benefit to the business, the staff are free to take this knowledge with them and hence we cannot control it. Therefore training costs need to be written off to profit or loss. The element that relates to sourcing and installing the hardware and software can be capitalised as part of the cost of the hardware (PPE) and software (intangible) accordingly. August 2016 7 Operational Case Study Exam
SECTION 4 CAMPAIGN DECISION Decision on the basis of expected value: There are two decisions facing Wise Choice Hotels, these are; whether to spend M$40,000 or M$70,000 on the campaign and whether to engage Expert Consultants to manage the campaign. If we do not engage Expert Consultants then the best decision using only expected values would be to choose campaign A. This is because it has the highest expected value of the two campaigns at M$17,000 (compared to M$12,000 for B). If we engage Expert Consultants then the best decision using only expected values would be to choose campaign B. This is because we would gain M$34,000 after allowing for the consultants costs of M$25,000, compared with only M$26,000 from campaign A. Considering the two decisions together, on the basis of expected values alone, we should select campaign B and engage Expert Consultants as the expected value of M$34,000 is greater than the M$17,000 from campaign A if the consultants are not engaged. This difference of M$17,000 represents the additional expected value to be created by engaging Expert Consultants to manage campaign B. Coefficient of variation: The coefficient of variation describes the amount of variability relative to the mean. It can be calculated by dividing the standard deviation by the expected value. Campaign B has a higher coefficient of variation which means that it has a greater spread of possible outcomes from a loss of M$10,000 to a profit of M$100,000. This means that campaign B is riskier than campaign A. The report from the Expert consultants shows that the coefficient of variation improves for both projects when their services are used and this claim needs to be substantiated. Factors to consider for this decision: An expected value is an average of the possible outcomes weighted by the probabilities of those outcomes occurring. It represents an average of the possibilities over a long period of time: it does not represent one of the possible outcomes. As a result, using the expected value rule to make a decision is only really appropriate over the long run where either the decision in question is repeated or the probabilities used can be based on long-run experience. A number of estimates are used here including the possible profits and losses and the probabilities. Given that Expert Consultants have a vested interest in selling their services to us, it is possible that the improvement in probability and expected profit that they predict is over-stated. Indeed it would seem that under campaign B they expect to reduce the probability of a loss to 30% from 60% and to also improve the end result under not successful conditions by M$20,000. This seems very optimistic; especially when we consider the improvement in the coefficient of variation (essentially the risk of the project) that they are predicting. It would be useful to undertake sensitivity analysis on the estimated August 2016 8 Operational Case Study Exam
probabilities as well as the revenue and costs associated with each decision option to understand how much each of these variables would need to change in order for the decision to change. This decision basis is a risk neutral basis: it ignores the range of the possible outcomes. The downside risk of campaign B is bigger than that of campaign A and expected values alone do not identify this. If we do not use the consultants there is a 60% chance of making a loss of M$30,000 with campaign B compared to a 40% chance of a loss of only M$10,000 with campaign A. With the consultant the relationship between campaign s A and B is the same in that the chance of a loss for B (30% chance of a total loss of M$35,000) is greater than that for campaign A (a 10% chance of a total loss of M$25,000). If the directors were risk adverse then campaign A is likely to be preferred as the coefficient of variation of campaign A is much lower than the coefficient of variation of campaign B. SYSTEM CHANGEOVER METHODS: There are a number of approaches to system changeover that we could use, each of which varies in terms of time the potential benefits and problems to our business. Four such approaches to system changeover and the associated benefits and problems are as follows: Direct changeover This is a Big Bang approach to systems changeover where our existing systems would be completely replaced by the new system in one move at a designated point in time. The benefit to us of this method is that it is quick and low cost, as it would require minimal resources. This might appear to be an attractive option as there are currently no IT support staff. However, there are potential problems with this approach that are particularly important when dealing with real-time systems such as those in our hotels. The most likely time for a system to fail is during the early days and weeks of its implementation. If our new system does fail, then we have no system to fall back on. We rely on our system for real-time advice to guests, booking and billing. Can we afford to take the risk of the direct changeover method, even if the software and hardware are well proven elsewhere? Parallel running This would involve running the existing system and the new system in parallel for a period of time. They both process current data that enables the output information of both systems to be compared and hence verifies the results produced by the new system prior to going live with it. This reduces many risks because, if anything goes wrong with the new system, it can be corrected and the old system can continue to run to deliver our real-time services to guests. This is a high cost low risk approach to systems changeover. This method might cause much organisational pain as it is time consuming due to the additional workload and at present we have limited IT resources. We would need to engage staff with the appropriate skills and more money to pay them. Pilot operation August 2016 9 Operational Case Study Exam
Pilot operation would involve selecting one of our hotels to operate the new system in parallel with our existing system. When the hotel operating the system is satisfied with the new system it would cease to use the existing system. The new system would then be piloted in another hotel. Pilot operation provides a greater degree of safety than a direct changeover and is less resource consumptive and lower cost and easier to control than parallel running. However this changeover method is not as safe as complete parallel running and can take a long time to achieve a total changeover. Phased or modular changeover Phased or modular changeover would involve selecting one sub-system such as the room reservations system for a direct changeover. When this sub-system is running satisfactorily, another sub-system is switched until eventually the whole of the existing system has been replaced by the new system. A phased series of direct changeovers is lower risk than a single direct changeover as any problems and disruption should be isolated in an area of operations. This could work well within Wise Choice Hotels. For example, we could set up the customer records sub-system first, and then move on to booking and billing. We would not need to implement inventory control and purchasing until later since there is little or no link between this and the customer-related sub-systems. This changeover method can take a long time to achieve a total changeover. August 2016 10 Operational Case Study Exam