Chapter 13, Problem 56P

Prepare Budgeted Financial Statements: Comparing Alternatives

Refer to the data in Problem 13-55. The managers of HomeSuites are considering different pricing strategies for year 2. Under the first strategy (“High Price”), they will work to maintain an average price of $210 per night. They realize that this will reduce demand and estimate that the occupancy rate will fall to 60 percent with this strategy. Under the alternative strategy (“High Occupancy”), they will work to increase the occupancy rate by lowering the average price. They estimate that with an average nightly rate of $170, they can achieve an occupancy rate of 80 percent.

For either of the two strategies, all the other estimates (cost per night, property costs, and so on) will be the same as in Problem 13-55.

Required

1. a.      Prepare a budgeted income statement for year 2 if the “High Price” strategy is adopted.
2. b.      Prepare a budgeted income statement for year 2 if the “High Occupancy” strategy is adopted.
3. c.       Make a recommendation to management for a pricing strategy for year 2. Explain your reasons.

To determine

Prepare a budgeted income statement for year 2 if the “High Price” strategy is adopted.

Explanation of Solution

High price strategy:

Under the high-price strategy, the company keeps the price of the product higher than its competitors. High-price strategy helps the company to achieve higher profit as the sales price is higher.

Prepare a budgeted income statement:

Company H Budgeted Income Statement For year 2
Particulars	Amount	Total amount
Sales revenue (1):
Lodging	$165,564,000
Food & beverage	$15,768,000
Miscellaneous	$7,884,000
Total revenue		$189,216,000
Operating costs:
Labor (4)	$46,620,000
Food & beverage (1)	$14,191,200
Miscellaneous (1)	$11,826,000
Management (2)	$2,700,000
Utilities (3)	$45,000,000
Depreciation (3)	$12,600,000
Marketing (2)	$27,500,000
Other costs	$8,000,000
Total operating cost		$168,437,200
Operating profit		$20,778,800

Table: (1)

Thus, the operating profit is $20,778,800 for company H for year 2.

Working note 1:

Calculate the revenue and costs for year 2:

Particulars	Total nights in a year 2 (8) (a)	Cost per night (5) (b)	% change (c)	Total amount $\text{d = (a}\times \text{b}\times \text{c)}$
Sales revenue:
Lodging	788,400	210	-	$165,564,000
Food & beverage	788,400	$25	0.8	$15,768,000
Miscellaneous	788,400	$10	-	$7,884,000
Costs:
food & beverage	788,400	$18	-	$14,191,200
Miscellaneous	788,400	$12	1.25	$11,826,000

Table: (2)

Working note 2:

Calculate the management and marketing costs:

Particulars	Amount (a)	% change (b)	Total amount     $C=\left(a\times b\right)$
Costs:
Management	2,500,000	1.08	2,700,000
Marketing	2,500,000	1.1	2,750,000

Table: (3)

Working note 3:

Calculate the utilities and depreciation:

Particulars	Amount (a)	Number of property in year 1 (b)	Cost per property     $\text{C =}\frac{\text{a}}{\text{b}}$	Number of property in year 2 (d)	Total cost in year 2 $\text{E = }\left(\text{c×d}\right)$
Costs:
Utilities	$3,750,000	15	$250,000	18	$4,500,000
Depreciation	$1,050,000	15	$70,000	18	$1,260,000

Table: (4)

Working note 4:

Calculate the labor cost:

Particulars	Cost per property (a)	Number of property (b)	Total nights in a year 2     $C=\left(a\times b\right)$	Variable labor cost per night (d)	Total variable cost     $E=\left(d*50\left(6\right)\right)$	Total cost     $F=\left(E+C\right)$
Labor cost	$400,000	18	$7,200,000	788,400	$39,420,000	$46,620,000

Table: (5)

Working note 5:

Particulars	Amount (a)	Total nights in a year (7) (b)	Cost per night     $C=\left(a\times b\right)$
Revenue:
Food & beverage	$19,162,500	766,500	$25
Miscellaneous	$7,665,000	766,500	$10
Costs:
Food & beverage	$13,797,000	766,500	$18
Miscellaneous	$9,198,000	766,500	$12

Table: (6)

Working note 6:

Calculate the average variable cost per unit:

Particulars	Total fixed labor cost (a)	Labor cost for year 1 (b)	Net labor cost     $\text{c = (a+b)}$	Total nights in a year (d)	Cost per night     $\text{e = }\frac{\text{d}}{\text{e}}$
Labor cost	$6,000,000	$44,325,000	$38,325,000	$766,500	$50

Table: (7)

The fixed labor cost per property is $400,000, and there are 15 properties so the total fixed labor cost will be $6,000,000$\left(\$400,000\times 15\right)$.

Working note 7:

Calculate the number of nights for year 1:

Number of properties (a)	Number of rooms in each property (b)	Days in a year (c)	Occupancy rate (d)	Total nights in a year     $\text{e = (a}\times \text{b}\times \text{c}\times \text{d)}$
15	200	365	70%	766,500

Table: (8)

Working note 8:

Calculate the number of nights for year 2:

Number of properties (a)	Number of rooms in each property (b)	Days in a year (c)	Occupancy rate (d)	Total nights in a year     $\text{e = (a}\times \text{b}\times \text{c}\times \text{d)}$
18	200	365	60%	788,400

Table: (9)

To determine

Prepare a budgeted income statement for year 2 if the “High Occupancy” strategy is adopted.

Explanation of Solution

High occupancy strategy:

Under the high-occupancy strategy, the company is very optimistic about the occupancy of the room. It estimates the highest probability of occupancy rate. Higher occupancy rate helps in increasing sales because the number of units sold has increased.

Prepare a budgeted income statement:

Company H Budgeted Income Statement For year 2
Particulars	Amount	Total amount
Sales revenue (9):
Lodging	$178,704,000
Food & beverage	$21,024,000
Miscellaneous	$10,512,000
Total revenue		$210,240,000
Operating costs:
Labor (10)	$59,760,000
Food & beverage (9)	$18,921,600
Miscellaneous (9)	$15,768,000
Management (2)	$2,700,000
Utilities (3)	$45,000,000
Depreciation (3)	$12,600,000
Marketing (2)	$27,500,000
Other costs	$8,000,000
Total operating cost		$190,249,600
Operating profit		$19,990,400

Table: (10)

Thus, the operating profit is $19,990,400 for company H for year 2.

Working note 9:

Calculate the revenue and costs for year 2:

Particulars	Total nights in a year 2 (11) (a)	Cost per night (5) (b)	% change (c)	Total amount $\text{d = (a}\times \text{b}\times \text{c)}$
Sales revenue:
Lodging	1,051,200	170	-	$178,704,000
Food & beverage	1,051,200	$25	0.8	$21,024,000
Miscellaneous	1,051,200	$10	-	$10,512,000
Costs:
food & beverage	1,051,200	$18	-	$18,921,600
Miscellaneous	1,051,200	$12	1.25	$15,768,000

Table: (11)

Working note 10:

Calculate the labor cost:

Particulars	Cost per property (a)	Number of property (b)	Total fixed cost     $C=\left(a\times b\right)$	Total nights in a year 2  (d)	Total variable cost     $E=\left(d*50\left(6\right)\right)$	Total cost     $F=\left(E+C\right)$
Labor cost	$400,000	18	$7,200,000	1,051,200	$52,560,000	$59,760,000

Table: (12)

Working note 11:

Calculate the number of nights for year 2:

Number of properties (a)	Number of rooms in each property (b)	Days in a year (c)	Occupancy rate (d)	Total nights in a year     $\text{e = (a}\times \text{b}\times \text{c}\times \text{d)}$
18	200	365	80%	1,051,200

Table: (13)