ABSTRACT. Activity-Based Costing (ABC) has been successfully applied
in the manufacturing industry for the last two decades. In this study,
a workable ABC model for restaurants was created and tested in a restaurant
operation in a western urban area of the United States. The study identified
that the actual cost of the dinner entrees was higher than the
restaurant?s prices, when analyzed using ABC methods. The results
revealed that ABC appears to be a very feasible method for establishing
accurate menu costs in restaurants. doi:10.1300/J149v08n03_01 [Article
copies available for a fee from The Haworth Document Delivery Service:
1-800-HAWORTH. E-mail address: Website:
? 2007 by The Haworth Press, Inc. All rights
reserved.]
KEYWORDS. Restaurants, profitability, activity-based costing, cost
accounting, menu pricing
Carola Raab, PhD, and Karl J. Mayer, PhD, both are Assistant Professors, Tourism
and Convention Department, William F. Harrah College of Hotel Administration,
University of Nevada, Nevada.
Stowe Shoemaker, PhD, is Associate Dean of Research, Conrad N. Hilton College,
University of Houston, Texas.
Address correspondence to: Carola Raab, Tourism and Convention Department,
William F. Harrah College of Hotel Administration, University of Nevada, 4505 Maryland
Parkway, Las Vegas, NV 89154 (E-mail: raab@unlv.nevada.edu).
International Journal of Hospitality & Tourism Administration, Vol. 8(3) 2007
Available online at http://ijhta.haworthpress.com
? 2007 by The Haworth Press, Inc. All rights reserved.
doi:10.1300/J149v08n03_01 1
INTRODUCTION
A major challenge for the restaurant industry in the twenty-first century
will be the ability of restaurant managers to find a balance between
appropriate product pricing and serving customers? diverse needs. One
theoretical approach that has provided manufacturing firms with a better
comprehension of costs and increased profitability stems from ActivityBased
Costing (ABC) theory (Cooper, 1989; Cooper & Kaplan, 1992).
ABC has major advantages over other costing methods by showing the
ability to trace overhead costs, which allows for more accurate unit costing
(Turney, 1991; Cooper & Kaplan, 1992). Furthermore, ABC infers
that activities are the antecedents of cost and that cost objects create the
demand for activities (Turney, 1991). Cooper and Kaplan (1988) pointed
out the general conditions that make companies good candidates for the
application of ABC systems, such as a diversity of resource consumption,
or the fact that product and resource consumption are not correlated with
traditional cost allocation methods. Rotch (1990) stated that these conditions
apply to service companies as well.
Even though ABC has been applied in such diverse service firms as
health care and financial institutions, ABC applications in the hotel or
restaurant industry are almost non-existent (Keller, 1994). The restaurant
industry generally establishes menu prices by using contribution
margin analyses. However, Kaplan and Cooper (1988) demonstrated
that the domain of traditional contribution margin analysis could be
greatly enhanced by the use of ABC. In addition, Kunst and Lemmik
(1995) pointed out the difficulties of tracing costs to activities and
activities to products and customers in restaurants.
Raab and Mayer (2003) interviewed controllers of a sample of the top
100 United States (U.S.) restaurant firms. Their study found that restaurant
managers are increasingly aware of the need to trace some of their
overhead costs, such as salaries and wages, to individual menu item
prices. Although approximately one-half of the respondents attempted
to measure processes and their costs, only one restaurant company was
able to gain knowledge of their labor costs by calculating activity-based
labor costs (Raab & Mayer, 2003). The results of their study indicate the
potential use of ABC in the restaurant industry.
However, few recent studies have discussed the application of ABC
in the restaurant business. Thus, this study examines whether it is feasible
and desirable to extend ABC philosophies to the restaurant industry.
The next section of this study examines the major challenges faced by
restaurant managers and the traditional methods the industry typically
2 International Journal of Hospitality & Tourism Administration
applies in order to manage costs and to create profits. In addition, it
discusses why the traditional methods applied by the restaurant industry
often do not maximize profits. Furthermore, it examines the opportunities
to maximize profits in the restaurant industry through the
application of ABC methods.
RESTAURANT INDUSTRY BACKGROUND
Challenges in the Restaurant Industry
Traditionally, the restaurant industry, with small profit margins and
high failure rates, is considered to be a risky business (NRA, 2001; Bell,
2002). A study conducted by American Express (2003) claimed that
9 out of 10 new restaurant openings go bankrupt during their first year
in business. Parsa (2003) challenged the American Express study results
and concludes that restaurant bankruptcies occurred at a somewhat
lower rate of 60 percent.
Nevertheless, most of the published research on restaurant failures
has concluded that the failure rates of new restaurants is relatively high
and that independently owned restaurants are especially prone to fail in
their first year of operation (Hume, 2002). The adverse economic conditions
that followed the terrorist attacks of September 11, 2001 negatively
affected the U.S. restaurant industry, which was borne out in unusually
high numbers of restaurant bankruptcy filings during 2002 (Hume,
2002). A study on business failures, including those in the restaurant
sector, identified two common problems that cause businesses to fail:
Ineffective financial control and poor marketing strategies (Wilke,
Josiam, Upchurch & Willems, 1996). As a result, the restaurant industry
is faced with a number of specific challenges. For example, restaurants
are very labor-intensive with labor costs often representing a large
share of total operating costs (Chan & Au, 1998; Quain, Sansbury &
LeBrutto, 1999). The control of labor costs is difficult, because service
provision is a major part of the product in the restaurant industry. While
restaurant patrons expect quality of food and beverage items, many
of them visit restaurants for the service experience itself. Therefore,
controlling labor costs without decreasing the level of service is a daunting
task, which creates the basic challenge of finding a balance between
serving customers? desires and achieving acceptable profitability levels.
Although restaurant managers generally are able to monitor their customer?s
needs, most of them lack specific knowledge of whether they
Raab, Shoemaker, and Mayer 3
will maximize overall profits by meeting their needs, in part because
restaurant managers often do not know the true profitability of their various
menu items (Raab & Mayer, 2003).
Some restaurant studies suggest approaches that incorporate labor
costs into menu item pricing (DeFranco & Noriego, 2000). However, in
reality, menu prices are rarely analyzed; at best, either a contribution
margin or menu engineering approach is applied to gain insights about
proper menu pricing (Raab & Mayer, 2003). Further, menu engineering
is based on a contribution margin analysis and cannot reveal the true
profitability of a menu item if menu prices are set without a thorough
knowledge of all operating costs. Clearly, these issues present significant
continuing challenges for the restaurant industry.
Maximizing Restaurant Profits Through ABC
The application of ABC methods allows a manager to trace undistributed
operating expenses to individual menu items, which could be beneficial
for several reasons. First, in the restaurant industry very little
attention is ordinarily paid to undistributed operating expenses when
product prices are established. Restaurant product prices are usually
calculated strictly as a function of cost of goods sold, along with a certain
mark-up percentage (Bell, 2002). Usually, individual menu item
prices only indirectly reflect any undistributed operating costs, such
as labor, utilities, or fixed costs. In recent years, these expenses have
increasingly captured a larger percentage of the total cost structure
of a restaurant. In highly competitive market conditions, proper pricing
measures become extremely important as profit margins are diminished.
Thus, restaurant operators may simply no longer be able to afford
to price based on simply marking up their variable product costs.
A more efficient and process-oriented restaurant organization could
achieve increased labor productivity, thereby decreasing total labor
costs, both directly and indirectly.
Second, an ABC analysis examines all major production activities
and allows for the identification and reduction of activities that cost
more than they add in value. These activities then can be either eliminated,
outsourced, or conducted more efficiently by the employees.
This type of analysis will assist not only in reducing organizational
waste, but also in eliminating service delays for guests. In any service
endeavor, all employees should be made responsible for the entire
process of achieving customer satisfaction and loyalty (Zeithaml &
Bitner, 2003).
4 International Journal of Hospitality & Tourism Administration
Third, once ABC are calculated, the accounting and marketing functions
can cooperatively apply Activity-Based Pricing (ABP) methods
by considering the relationships between ABC and menu prices determined
at the point where total profits are maximized as well as
value is created for customers (Daly, 2002). For example, research by
Cardinaels, Roodhooft and Warlop (2004) found that using ABC analysis
to help make pricing decisions could have significant positive
impacts for multiple market segments under highly competitive conditions,
which is typically the case for most hospitality markets. Thus, it
seems quite apparent that ABC methods might be applied to the restaurant
industry with some tangible benefits.
The remainder of this paper will demonstrate how the basic principles
of ABC can be applied to the restaurant business. In doing so, it
addresses two principal research questions: (1) Can an ABC approach
trace restaurant overhead costs through activity centers to individual
menu items; and, (2) can an ABC approach reveal the true cost structure
of individual menu items?
In order to address these questions, an ABC model for the restaurant
industry was needed, as one did not already exist. An ABC model for
restaurants was developed by modifying Cooper?s (1989) ABC model
for the manufacturing industry. Following Cooper?s (1989) approach, a
qualitative case analysis technique, which incorporated both observation
and interview methods, was applied to this study. The result of the
case analysis was an ABC model that was applicable to a full-service
restaurant (Figure 1).
Next, a methodology for applying the model was created that allowed
for the practical application of ABC in a restaurant setting (Cooper,
1989; O?Guin, 1991; Keller, 1994; Garrison & Noreen, 1997; Cokins,
2001; Daly, 2002). The model and its methodology were prepared in
conjunction with the management of a full-service restaurant in the
western United States to ensure that the approach was fundamentally
sound. Dinner entr?es were selected as the menu items to be analyzed in
this study because management expressed concerns about the profitability
of the restaurant?s dinner menu.
AN ABC APPROACH FOR RESTAURANTS
The first step of an ABC analysis is the identification of activities and
activity centers. Activity centers are established across departments and
accountability structures by combining homogenous processes. For a
Raab, Shoemaker, and Mayer 5
restaurant, it was appropriate to create two activity centers: The Frontof-the-House
(FOH); and, the Back-of-the House (BOH). Individual
activities in the restaurant were then identified so they could be classified
into either activity center. Major activities in the restaurant industry
are myriad, and include purchasing, receiving, storing, food preparation,
cooking, cleaning, dining room set-up, customer seating, taking
orders, ordering and serving food and beverages, table maintenance, ca
shing out customers, and customer communication. However, all activities
were ultimately coded as either FOH or BOH activities. They
were then classified in an Activity Dictionary, as shown in Tables 1 and 2,
so they could be easily communicated to all restaurant employees and to
facilitate further analysis.
Garrison and Noreen (1997) suggest that all activities should be
detailed in a Process Value Analysis (PVA), which is a flow chart that
reveals all activities conducted in an organization and labels them as
value-added and non-value added. In the restaurant industry, only activities
that actually produce the product or provide service to the customer
are value-added. For example, all customer communications occurring in
6 International Journal of Hospitality & Tourism Administration
Restaurant Activity-Based Cost Model
General Ledger
Personnel
First
Stage
Second
Stage
Unit-Level
Batch-Level
Product-Sustaining
Unit-Level
Batch-Level
Product-Sustaining
Facility-Sustaining
Food Cost
BOH Activitiy Center
Dinner Entr?es
FOH Activitiy Center
Unit-Level
Batch-Level
Product-Sustaining
Direct Operating Facility-Sustaining
FIGURE 1. Activity-Based Model for Restaurants
the Front-of-the-House and the production of menu items in the Backof-the
House are value-added activities. Non-value added activities
include receiving, storing, moving goods, and waiting for processing.
Basically, most non-value added activities consume resources without
adding value to the product. Therefore, in order to minimize costs in a
restaurant, such activities should be carefully examined by means of a
PVA approach.
The next phase of applying ABC to a restaurant involved the examination
of the general ledger and the assignment of overhead costs
Raab, Shoemaker, and Mayer 7
TABLE 2. Activity Dictionary (Front-of-the-House)
Main Activities Description
Communicating Taking orders, interaction with customers, greeting customers, explain
menu, sell menu items, taking reservations, answering phones,
checking on guest satisfaction, seating people, communicating
between bussers, management and servers.
Cleaning Keeping menus in order, cleaning floors, maintaining tables, and
cleaning ashtrays.
Set-up Folding napkins, polishing silver, dining room set up (set tables, side
station), making coffee, processing checks, process orders, (inputting
into the Point-of-Sales System), close tabs.
Serving customers Serve water, pick up orders, serve meals, time orders, bringing
condiments to table, replacing cutlery, present check, collect
payment, and make change,
Administrating Supervision, forecasting, scheduling, and training.
TABLE 1. Activity Dictionary (Back-of-the-House)
Main Activities Description
Cleaning Dish-washing, disinfecting, cleaning floors, washing pots, refill soap hand
wash stations, cleaning walls, counters, hoods, staff bathrooms, refrigerators,
storage, beverage machines, removing trash, and washing hands.
Preparation Selecting, washing, cutting fruit and vegetables, defrosting, pre-portioning,
sauces and soups, cutting meat, grinding meat, mixing ingredients, and
line set-up.
Cooking Preparing hot meals, expediting, read orders and time orders, dish out
soup, cook sides, fry meat and seafood, arrange items on plate and
garnish, keep food warm, preparing salad, put together ingredients,
preparing desserts, cut cake and dish ice cream, whip cream, bake,
broil, blanch, stewing and, plate set-up.
Administrating Purchasing, budgeting, supervising, menu research, create menus and
items, scheduling, training staff, receiving, storing, and forecasting.
into homogeneous cost pools. According to the Uniform System of
Accounts for Restaurants, overhead costs include the following items:
(1) Salaries and Wages; (2) Employee Benefits; (3) Direct Operating
Expenses; (4) Music and Entertainment; (5) Marketing; (6) Utility Service;
(7) General and Administrative Expenses; and, (8) Repair and
Maintenance Expenses (Schmidgall, 1997). Homogeneous cost pools
are a collection of overhead costs for which cost variations can be
explained by only one first stage cost driver and that share a common
purpose in the operation of the facility. An example of a first stage cost
driver is the number of hours worked by the employees. This first stage
cost driver is applicable to all labor related overhead costs.
Working with restaurant management and following the model guidelines
(Figure 1), three separate cost pools were created?labor, direct
operating supplies, and facility sustaining. The first two cost pools contained
overhead costs that were directly traceable to individual menu
items. On the other hand, the facility sustaining cost pool contained all
other overhead costs for which no first stage cost driver could be identified.
Therefore, no cost driver rates were established for this cost pool.
Next, the labor and direct operating supplies cost pools were divided by
the number of cost driver units, which established a cost driver rate for
each of them. These pool rates were later applied as an internal costing
mechanism for the dinner entr?es, to reflect the cost of resources they
consumed at each activity level.
The next step of an ABC process divides each activity center into a
second stage, and establishes ?second stage? cost drivers by dividing
the total costs of each activity center into activity cost driver pools.
According to ABC theory, all activities have a hierarchy, and cost drivers
enable the activities to be grouped into different levels, such as unitbased,
batch-related, product-related, or facility sustaining (Cooper,
1990; Turney, 1991; O?Guin, 1991; Garrison & Noreen, 1997).
Thus, there are four categories of second stage cost drivers applicable
to the restaurant industry. The first is unit cost drivers, which occur anytime
a unit is produced and are directly related to the number of units
produced. The number of employee hours and units of utilities used are
unit-based cost drivers applicable to the restaurant industry. The second
category, batch cost drivers, incorporate everything that is produced in
batches such as setting up the kitchen line or purchasing inventory. The
third category, product level drivers, signify resources used by productlevel
activities that are performed to sustain products in the company?s
product line. In a restaurant, some examples of product-level activities
include establishing and maintaining specifications, recipe testing, and
8 International Journal of Hospitality & Tourism Administration
expediting food production. Finally, the facility sustaining cost driver
category contains costs that sustain a company?s general processes such
as accounting, marketing, property taxes, security and landscaping.
According to ABC theory, each of the activity cost driver pools has
its cost assigned to products using a second stage cost driver that is unique
to each cost pool. A cost driver pool is distributed to products based on
the number of cost driver units it consumes. The overhead cost applied
to the product is calculated by multiplying the number of cost driver
units with the cost pool rates established during the first stage of an
ABC process. Finally, ABC costs that were calculated for each entree
were condensed as bills of activity. A completed bill of activity becomes
a powerful tool for analysis and subsequent action by restaurant management.
An example of a completed bill of activity that resulted from
this study for a dinner entr?e (Pasta Marinara) is presented in Table 3.
Since the restaurant involved in this study operated at a loss, all overhead
costs were a major source of concern by management. However,
similar to most restaurant operations, labor and related costs represented
by far the greatest source of concern to management. Therefore,
the main objective for the study became the ability to trace labor and
related costs to each entr?e. In addition, management also wanted to
trace all direct operating supplies to individual dinner menu items.
Thus, three cost pools were established along these lines: (1) A ?Personnel?
cost pool, which included all salaries, overtime pay, and wages for
temporary help, all employer taxes, worker compensation expenses,
employer insurance, and employee meal accounts; (2) a ?Direct Operating
Supplies? cost pool, incorporating the uniform and laundry account
as well as the disposable supplies account; and (3) a ?Facility Sustaining?
cost pool, including the utility, repair and maintenance, accounting,
general and administrative expenses, insurance, security, landscaping,
telephone, marketing, travel and entertainment, and equipment depreciation
accounts.
Next, the three cost pools were assigned to the two activity centers
(FOH and BOH) and cost pool rates were calculated. Table 4 displays
the results of this process for the first two cost pools, including their associated
cost pool rates. Table 4 does not display the facility sustaining
cost pool because according to the ABC literature, cost pool rates can
only be calculated from cost pools that can be traced to individual menu
items (O?Guin, 1991; Garrison & Noreen, 1997). Instead, an allocation
value was established for the facility sustaining cost pool based on the
number of dinner entrees that were sold during the month of November
2003. This approach for these costs is consistent with ABC theory in
Raab, Shoemaker, and Mayer 9
manufacturing, which ultimately allocates a portion of the total overhead
costs that cannot be traced to individual items. All figures shown
in Table 4 were obtained from the restaurant?s general ledger for
November 2003, which was provided by restaurant management. Both
activity centers were then divided into cost driver pools and levels of
activities were established.
10 International Journal of Hospitality & Tourism Administration
TABLE 3. Completed Bill of Activity for Pasta Marinara Entr?e
Activities Resources
Used
Cost Pool Rates
($/Minute)
Total Cost $
Unit-Level Activities?FOH
Communicating 1.20 minutes 0.39 0.47
Setting-up 1.00 minutes 0.39 0.39
Serving customers 1.00 minutes 0.39 0.39
Processing checks 1.45 minutes 0.39 0.56
Total 4.65 minutes 1.81
Unit Level Activities?BOH
Preparation 2.0 minutes 0.17 0.34
Cooking 2.0 minutes 0.17 0.34
Cleaning 1.0 minutes 0.17 0.17
Total 5.0 minutes 0.85
Total unit-level activities 9.65 minutes 2.66
Batch-Level Activities?FOH
Setting-up 3.20 minutes 0.39 1.25
Cleaning 1.59 minutes 0.39 0.62
Administrating 3.83 minutes 0.39 1.49
Total 8.62 minutes 3.36
Batch-Level Activities?BOH
Preparation 6.13 minutes 0.17 1.04
Cleaning 5.55 minutes 0.17 0.94
Total 11.68 minutes 1.98
Total batch-level activities 20.30 minuts 5.29
Product-Sustaining Activities
FOH?Administrating 2.55 minutes 0.39 0.99
BOH?Administrating 3.21 minutes 0.17 0.55
Total Product-Sustaining Activities 5.76 1.54
Facility-sustaining activities 1 unit 5.29
Direct operating costs 4.97 percent 0.26 1.29
Food costs 1 unit 2.00
Total cost 18.07
Observation and interview methods were employed to identify second
stage cost drivers and activity hierarchies, which divided the two
activity centers into unit-level, batch-level, product-related, and facility
sustaining cost pools. Basic second stage cost drivers for unit-level activities
were identified as time spent on activities conducted each time a
customer is served and an entr?e is produced. General cost drivers for
batch-level activities were the number of batches required, such as
number of set-ups per day, or the number of times purchasing and receiving
is needed during the month. Major product-sustaining cost drivers
were identified as the number of new menu items created each
month and the number of new employees hired per month. The results
of the ABC process became a completed bill of activity for each menu
entr?e (Table 3), which allowed restaurant management to truly understand
the cost structure of its menu for the first time.
DISCUSSION
The ABC approach described in this study revealed that the dinner
menu, which contained fourteen individual entr?es, was the major
contributor to the restaurant?s negative operating profit. This result
reflects the restaurant?s relatively high overhead costs, and particularly
its high labor costs. In this case, the entr?es? actual costs were higher
than the restaurant?s menu prices, if analyzed using ABC methods.
Therefore, every time a dinner entr?e was sold, with the exception of
Raab, Shoemaker, and Mayer 11
TABLE 4. Cost Pool Rates
Activity Centers Personnel Direct Operating Supplies
FOH $23.60/hour
($11,545/489 hours)
$0.26/entr?e
($218.24/828 units consumed)
FOH cost pool rate
calculations
Total labor cost/hours worked Total direct operating costs/units
used
BOH $10.22/hour
($4686.75/458.50 hours)
$0.26/entr?e
($509.23/1932 units consumed)
BOH cost pool rate
calculations
Total labor cost/hours worked Total direct operating
costs/units used
Note: All figures shown in the table were obtained from restaurant management for the month of November
2003; for example, the hours used came from the restaurant?s payroll records, and the units consumed represent
actual supplies that were used during the month.
three entrees that could be classified as very profitable, the restaurant
suffered an operating loss.
In addition, the analysis of the general ledger cost pools provided
some compelling insights. First, the separation of overhead costs into
homogenous cost pools and their assignment to the FOH and BOH activity
centers revealed where major costs occurred with far more precision.
For example, for the dinner shift observed in this study, the FOH
incurred 61 percent of the overhead costs; of that figure, the FOH ?Personnel?
cost pool represented over half (53 percent) of all overhead
costs. The detailed analysis of labor costs and hours necessary to establish
the ?Personnel? cost pool and a cost pool rate identified that the
hourly wages paid at the restaurant involved in this study are much
higher than restaurants traditionally pay for their labor.
In addition, the analysis showed that the BOH incurred overtime hours
for 53 percent of all hours worked. The use of part-time employees and
more sophisticated demand forecasting methods are some likely solutions
that could result in the reduction of overtime hours for this establishment.
Another opportunity for management to reduce FOH labor costs arises
from the use of PVA to reduce and eliminate any non-value added activities.
For example, in the restaurant involved in this study, approximately
one-half of all the existing activities in the BOH and FOH are consuming
resources without directly assisting in producing products or providing
service to the customer. This seems much too great a commitment to
non-value added activities. Therefore, management should review all
non-value added activities and use this information to improve the establishment?s
processes. Some of the non-value added activities that were
identified should be eliminated, such as personal conversations and extensive
personal phone calls. Other non-value added activities could be
candidates for outsourcing. For example, non-value added food preparation
activities in the BOH could be reduced if pre-cut and pre-washed
produce is purchased and meat and fish product are purchased already
portioned. Finally, it may be advisable to outsource some of the cleaning
activities such as the cleaning of hoods, walls and restrooms. Even
though these actions may be considered common sense for a restaurant
manager, the significance these insights might not have been identified if
the restaurant had not been subjected to an ABC analysis.
These insights are consistent with the thrust of ABC applications in
the business literature, which suggest that if products consume diverse
amounts of resources, the ABC method will reveal dramatically different
product costs in comparison to product cost methods that are based solely
on contribution margins (Cooper, 1989). Indeed, this study revealed that
12 International Journal of Hospitality & Tourism Administration
overhead costs were consumed at a diverse resource consumption rate
by each entr?e.
IMPLICATIONS AND LIMITATIONS
This study demonstrated that ABC methods can be successfully
applied to a restaurant. The ABC model that was developed in this study
can be applied to virtually any full-service restaurant, but the results of
such a study would likely be different from this one, depending upon the
market characteristics and cost structure of that particular restaurant.
Nevertheless, applying ABC methods can assist to restaurant operators
in a number of ways. First, ABC can enhance restaurant feasibility analysis
by making menu planning more accurate relative to individual item
profitability. Second, ABC methods can help a restaurant identify
which menu items are truly profitable and which ones are not, given the
restaurant?s customer profile. Third, ABC methods can assist in evaluating
promotions, such as the decision to use a price discount on a featured
item to boost sales; ABC can help determine whether that decision
will incur a profit or loss for the promotion.
Although it is only a single case study of a restaurant, the findings indicate
that restaurant managers should make menu decisions using more
complete cost information. It also suggests that applications of menu
profitability analyses that go beyond the simple analysis of food costs
may be very appropriate for a restaurant. Restaurant managers can make
much more reliable decisions with complete cost information, which
emphasizes the need to calculate ABC costs for each item on the menu.
Furthermore, this study supports Cooper?s (1989) view that the lack
of precise product overhead costs may totally distort total product cost
and price, which was the case for this restaurant. Thus, it is likely that a
restaurant manager?s menu management decisions will differ dramatically
if he or she is confronted with differing results from a contribution
margin or an ABC approach. Of course, many other factors besides cost
also enter into menu pricing decisions, such as customer perceptions of
value and quality, customer segmentation, and competition.
This study contains a number of limitations that should be noted.
First, although the ABC model that was developed could be applied to
other full-service restaurants, the specific findings of this study cannot
be generalized to the restaurant industry as a whole, or to other restaurant
types, without further research. Second, this study only examined the
restaurant?s dinner entrees; the restaurant?s beverage service and its
Raab, Shoemaker, and Mayer 13
lunch menu were not included herein. Thus, no conclusions can be
drawn about the restaurant?s situation on an overall basis since a complete
ABC analysis of all food and beverage items was not done.
SUMMARY
This study was able to develop and apply a workable ABC model for
a restaurant, which established a unique overhead cost value for each
menu item. This process allowed for the calculation of bills of activities
for all entr?es, which included both the overhead costs and food cost per
entr?e. Therefore, this study was able not only to assign accurate overhead
rates, but also to provide true product cost information for the restaurant
in the form of operating profit margins for each entr?e. It
suggests that ABC methods can be applied in the restaurant industry,
and may allow for greatly improved financial analyses that incorporate
more precise and complete cost information. Thus, the study revealed
that the application of ABC methods to restaurants is not only feasible,
but also highly informative.
Future research on this topic should include determining whether ABC
methods can be applied to other restaurant types, such as buffet, quick
service, or casual dining venues. In addition, the ABC analysis should incorporate
all meal periods in a restaurant, so that an overall picture of the
operation can be determined. Further, the potential application of ABC
methods to other hospitality sectors, such as hotels, spas, or casinos,
should be investigated. Finally, it would also be beneficial to conduct a
study that combines ABC with a price sensitivity analysis, which would
incorporate both costing and pricing aspects of a hospitality operation.
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Kaplan, R. & Cooper, R. (1988). Measure Costs Right: No longer. Journal of Management
Accounting Research (Fall), 2-15.
Keller, B. (1994). Activity-Based Costing for the Hotel Industry, [Monograph].
Cornell University.
Kunst, P. & Lemmik, J. (1995). Managing Service Quality. London: Paul Chapman
Publishing Ltd.
National Restaurant Association (2001). Retrieved April 4, 2003 fromwww.restaurant.org
O?Guin, M. (1991). The Complete Guide to Activity-Based Costing, NY: Prentice Hall.
Parsa, H. (2003). Retrieved September 15, 2004 from http://www.researchnews.osu.
edu/archive/restfail.htm.
Quain, E., Sansbury, M. & LeBrutto, S. (1999). Revenue Enhancement, Part 4, Cornell
Hotel and Restaurant Administration Quarterly, 40(3), 38-47.
Raab, C & Mayer, K.J. (2003). Exploring the use of activity based costing in the restaurant
industry, Int’l Journal of Hosp. & Tourism Admin, 4(2) 79-96.
Rotch, W. (1990). Activity-Based Costing in Service Industries, Journal of Cost Management,
Summer, 4-14.
Schmidgall, R. (1997). Hospitality Industry Managerial Accounting, 4th ed., Lansing,
MI: Educational Institute American Hotel & Motel Association.
Turney, P. (1991). Common Cents. The ABC Performance Breakthrough, Cost Technology,
13-17.
Wilke, E., Josiam, B., Upchurch, R. & Willems, J. (1996). Restaurant Attrition: A Longitudinal
Analysis of Restaurant Failures, International Journal of Contemporary
Hospitality Management, 8(2), 17-20.
Zeithaml, V. & Bitner, M. (2003). Services Marketing: Integrating Customer Focus
Accross the Firm, 3rd ed., New York: McGraw Hill.
RECEIVED: 10/08/05
REVISIONS RECEIVED: 12/29/05
ACCEPTED: 01/17/06
doi:10.1300/J149v08n03_01
Raab, Shoemaker, and Mayer 15

Quiz 4
Names:
Read chapter 5 and answer questions 1 ? 7 (10 points each) and read the attached article to answer question 8 (30 points). Bring your answers to class on Tuesday October 25.

1. If a bartender can somehow accumulate extra liquor, and does not register the extra drinks, which of these activities could be spotted by the analytical methods we studied?
A. The bartender steals the extra liquor
B. The drinks are given away in hopes the guests will be generous with tips
C. The drinks are sold and the money deposited by the bartender
D. The drinks are sold and the revenue kept by the bartender

2. Which of these controls would be recommended to prevent bar personnel from bring in their own bottles?
1. Par stock
2. Daily inventory
3. Use of lined shot glasses
4. Bottle tags or stickers
5. Use of a perpetual inventory
A. 1, 3, 4
B. 1, 4
C. 2, 4, 5
D. 1, 2

3. If a bartender were overpouring:
A. There would not be a variance between the standard and actual revenue
B. The actual usage would be more than the standard
C. The inventory would show a difference in the par stock
D. The standard cost would be higher than the actual

4. If a bartender was underpouring and not registering the extra drinks (but keeping the extra revenue), which of the following would be true?
A. There would be a variance between the actual and the standard revenue.
B. The actual usage would be higher than the standard usage.
C. There would be no variances in any of the analysis methods we studied
D. The actual percentage would be higher than it should be
E. The actual dollar cost would be less than the standard dollar cost

5. If a bartender were substituting a well scotch for a premium scotch, charging the guest the premium price, and was ringing up the well price; what would your analysis show?
a) The revenue for the premium brand would be low
b) None of these
c) The usage of the premium brand would be excessive
d) The usage of the well brand would be excessive
e) The revenue for the well brand would be low

6. If a bartender brought in his/her own bottle, there is a potential of which of these?
a. The portion sizes can vary
b. Additional drinks
c. Standard portion size larger than the actual
d. Actual revenue less than the standard

7. With a no host bar, the major danger is:
a. Bartenders not pouring standard portions
b. Bartenders padding the catering bill and moving the bottles to the bar
c. Bartenders stealing liquor
d. Bartender stealing cash.

8. (30 points)
Please read the attached article (Activity-Based Costing:
A More Accurate Way to Estimate the Costs for a Restaurant Menu, Raab
Shoemaker and Mayer) and describe the advantages of using Activity-Based Costing (ABC) methods in a restaurant.

ABSTRACT. Activity-Based Costing (ABC) has been successfully applied
in the manufacturing industry for the last two decades. In this study,
a workable ABC model for restaurants was created and tested in a restaurant
operation in a western urban area of the United States. The study identified
that the actual cost of the dinner entrees was higher than the
restaurant?s prices, when analyzed using ABC methods. The results
revealed that ABC appears to be a very feasible method for establishing
accurate menu costs in restaurants. doi:10.1300/J149v08n03_01 [Article
copies available for a fee from The Haworth Document Delivery Service:
1-800-HAWORTH. E-mail address: Website:
? 2007 by The Haworth Press, Inc. All rights
reserved.]
KEYWORDS. Restaurants, profitability, activity-based costing, cost
accounting, menu pricing
Carola Raab, PhD, and Karl J. Mayer, PhD, both are Assistant Professors, Tourism
and Convention Department, William F. Harrah College of Hotel Administration,
University of Nevada, Nevada.
Stowe Shoemaker, PhD, is Associate Dean of Research, Conrad N. Hilton College,
University of Houston, Texas.
Address correspondence to: Carola Raab, Tourism and Convention Department,
William F. Harrah College of Hotel Administration, University of Nevada, 4505 Maryland
Parkway, Las Vegas, NV 89154 (E-mail: raab@unlv.nevada.edu).
International Journal of Hospitality & Tourism Administration, Vol. 8(3) 2007
Available online at http://ijhta.haworthpress.com
? 2007 by The Haworth Press, Inc. All rights reserved.
doi:10.1300/J149v08n03_01 1
INTRODUCTION
A major challenge for the restaurant industry in the twenty-first century
will be the ability of restaurant managers to find a balance between
appropriate product pricing and serving customers? diverse needs. One
theoretical approach that has provided manufacturing firms with a better
comprehension of costs and increased profitability stems from ActivityBased
Costing (ABC) theory (Cooper, 1989; Cooper & Kaplan, 1992).
ABC has major advantages over other costing methods by showing the
ability to trace overhead costs, which allows for more accurate unit costing
(Turney, 1991; Cooper & Kaplan, 1992). Furthermore, ABC infers
that activities are the antecedents of cost and that cost objects create the
demand for activities (Turney, 1991). Cooper and Kaplan (1988) pointed
out the general conditions that make companies good candidates for the
application of ABC systems, such as a diversity of resource consumption,
or the fact that product and resource consumption are not correlated with
traditional cost allocation methods. Rotch (1990) stated that these conditions
apply to service companies as well.
Even though ABC has been applied in such diverse service firms as
health care and financial institutions, ABC applications in the hotel or
restaurant industry are almost non-existent (Keller, 1994). The restaurant
industry generally establishes menu prices by using contribution
margin analyses. However, Kaplan and Cooper (1988) demonstrated
that the domain of traditional contribution margin analysis could be
greatly enhanced by the use of ABC. In addition, Kunst and Lemmik
(1995) pointed out the difficulties of tracing costs to activities and
activities to products and customers in restaurants.
Raab and Mayer (2003) interviewed controllers of a sample of the top
100 United States (U.S.) restaurant firms. Their study found that restaurant
managers are increasingly aware of the need to trace some of their
overhead costs, such as salaries and wages, to individual menu item
prices. Although approximately one-half of the respondents attempted
to measure processes and their costs, only one restaurant company was
able to gain knowledge of their labor costs by calculating activity-based
labor costs (Raab & Mayer, 2003). The results of their study indicate the
potential use of ABC in the restaurant industry.
However, few recent studies have discussed the application of ABC
in the restaurant business. Thus, this study examines whether it is feasible
and desirable to extend ABC philosophies to the restaurant industry.
The next section of this study examines the major challenges faced by
restaurant managers and the traditional methods the industry typically
2 International Journal of Hospitality & Tourism Administration
applies in order to manage costs and to create profits. In addition, it
discusses why the traditional methods applied by the restaurant industry
often do not maximize profits. Furthermore, it examines the opportunities
to maximize profits in the restaurant industry through the
application of ABC methods.
RESTAURANT INDUSTRY BACKGROUND
Challenges in the Restaurant Industry
Traditionally, the restaurant industry, with small profit margins and
high failure rates, is considered to be a risky business (NRA, 2001; Bell,
2002). A study conducted by American Express (2003) claimed that
9 out of 10 new restaurant openings go bankrupt during their first year
in business. Parsa (2003) challenged the American Express study results
and concludes that restaurant bankruptcies occurred at a somewhat
lower rate of 60 percent.
Nevertheless, most of the published research on restaurant failures
has concluded that the failure rates of new restaurants is relatively high
and that independently owned restaurants are especially prone to fail in
their first year of operation (Hume, 2002). The adverse economic conditions
that followed the terrorist attacks of September 11, 2001 negatively
affected the U.S. restaurant industry, which was borne out in unusually
high numbers of restaurant bankruptcy filings during 2002 (Hume,
2002). A study on business failures, including those in the restaurant
sector, identified two common problems that cause businesses to fail:
Ineffective financial control and poor marketing strategies (Wilke,
Josiam, Upchurch & Willems, 1996). As a result, the restaurant industry
is faced with a number of specific challenges. For example, restaurants
are very labor-intensive with labor costs often representing a large
share of total operating costs (Chan & Au, 1998; Quain, Sansbury &
LeBrutto, 1999). The control of labor costs is difficult, because service
provision is a major part of the product in the restaurant industry. While
restaurant patrons expect quality of food and beverage items, many
of them visit restaurants for the service experience itself. Therefore,
controlling labor costs without decreasing the level of service is a daunting
task, which creates the basic challenge of finding a balance between
serving customers? desires and achieving acceptable profitability levels.
Although restaurant managers generally are able to monitor their customer?s
needs, most of them lack specific knowledge of whether they
Raab, Shoemaker, and Mayer 3
will maximize overall profits by meeting their needs, in part because
restaurant managers often do not know the true profitability of their various
menu items (Raab & Mayer, 2003).
Some restaurant studies suggest approaches that incorporate labor
costs into menu item pricing (DeFranco & Noriego, 2000). However, in
reality, menu prices are rarely analyzed; at best, either a contribution
margin or menu engineering approach is applied to gain insights about
proper menu pricing (Raab & Mayer, 2003). Further, menu engineering
is based on a contribution margin analysis and cannot reveal the true
profitability of a menu item if menu prices are set without a thorough
knowledge of all operating costs. Clearly, these issues present significant
continuing challenges for the restaurant industry.
Maximizing Restaurant Profits Through ABC
The application of ABC methods allows a manager to trace undistributed
operating expenses to individual menu items, which could be beneficial
for several reasons. First, in the restaurant industry very little
attention is ordinarily paid to undistributed operating expenses when
product prices are established. Restaurant product prices are usually
calculated strictly as a function of cost of goods sold, along with a certain
mark-up percentage (Bell, 2002). Usually, individual menu item
prices only indirectly reflect any undistributed operating costs, such
as labor, utilities, or fixed costs. In recent years, these expenses have
increasingly captured a larger percentage of the total cost structure
of a restaurant. In highly competitive market conditions, proper pricing
measures become extremely important as profit margins are diminished.
Thus, restaurant operators may simply no longer be able to afford
to price based on simply marking up their variable product costs.
A more efficient and process-oriented restaurant organization could
achieve increased labor productivity, thereby decreasing total labor
costs, both directly and indirectly.
Second, an ABC analysis examines all major production activities
and allows for the identification and reduction of activities that cost
more than they add in value. These activities then can be either eliminated,
outsourced, or conducted more efficiently by the employees.
This type of analysis will assist not only in reducing organizational
waste, but also in eliminating service delays for guests. In any service
endeavor, all employees should be made responsible for the entire
process of achieving customer satisfaction and loyalty (Zeithaml &
Bitner, 2003).
4 International Journal of Hospitality & Tourism Administration
Third, once ABC are calculated, the accounting and marketing functions
can cooperatively apply Activity-Based Pricing (ABP) methods
by considering the relationships between ABC and menu prices determined
at the point where total profits are maximized as well as
value is created for customers (Daly, 2002). For example, research by
Cardinaels, Roodhooft and Warlop (2004) found that using ABC analysis
to help make pricing decisions could have significant positive
impacts for multiple market segments under highly competitive conditions,
which is typically the case for most hospitality markets. Thus, it
seems quite apparent that ABC methods might be applied to the restaurant
industry with some tangible benefits.
The remainder of this paper will demonstrate how the basic principles
of ABC can be applied to the restaurant business. In doing so, it
addresses two principal research questions: (1) Can an ABC approach
trace restaurant overhead costs through activity centers to individual
menu items; and, (2) can an ABC approach reveal the true cost structure
of individual menu items?
In order to address these questions, an ABC model for the restaurant
industry was needed, as one did not already exist. An ABC model for
restaurants was developed by modifying Cooper?s (1989) ABC model
for the manufacturing industry. Following Cooper?s (1989) approach, a
qualitative case analysis technique, which incorporated both observation
and interview methods, was applied to this study. The result of the
case analysis was an ABC model that was applicable to a full-service
restaurant (Figure 1).
Next, a methodology for applying the model was created that allowed
for the practical application of ABC in a restaurant setting (Cooper,
1989; O?Guin, 1991; Keller, 1994; Garrison & Noreen, 1997; Cokins,
2001; Daly, 2002). The model and its methodology were prepared in
conjunction with the management of a full-service restaurant in the
western United States to ensure that the approach was fundamentally
sound. Dinner entr?es were selected as the menu items to be analyzed in
this study because management expressed concerns about the profitability
of the restaurant?s dinner menu.
AN ABC APPROACH FOR RESTAURANTS
The first step of an ABC analysis is the identification of activities and
activity centers. Activity centers are established across departments and
accountability structures by combining homogenous processes. For a
Raab, Shoemaker, and Mayer 5
restaurant, it was appropriate to create two activity centers: The Frontof-the-House
(FOH); and, the Back-of-the House (BOH). Individual
activities in the restaurant were then identified so they could be classified
into either activity center. Major activities in the restaurant industry
are myriad, and include purchasing, receiving, storing, food preparation,
cooking, cleaning, dining room set-up, customer seating, taking
orders, ordering and serving food and beverages, table maintenance, ca
shing out customers, and customer communication. However, all activities
were ultimately coded as either FOH or BOH activities. They
were then classified in an Activity Dictionary, as shown in Tables 1 and 2,
so they could be easily communicated to all restaurant employees and to
facilitate further analysis.
Garrison and Noreen (1997) suggest that all activities should be
detailed in a Process Value Analysis (PVA), which is a flow chart that
reveals all activities conducted in an organization and labels them as
value-added and non-value added. In the restaurant industry, only activities
that actually produce the product or provide service to the customer
are value-added. For example, all customer communications occurring in
6 International Journal of Hospitality & Tourism Administration
Restaurant Activity-Based Cost Model
General Ledger
Personnel
First
Stage
Second
Stage
Unit-Level
Batch-Level
Product-Sustaining
Unit-Level
Batch-Level
Product-Sustaining
Facility-Sustaining
Food Cost
BOH Activitiy Center
Dinner Entr?es
FOH Activitiy Center
Unit-Level
Batch-Level
Product-Sustaining
Direct Operating Facility-Sustaining
FIGURE 1. Activity-Based Model for Restaurants
the Front-of-the-House and the production of menu items in the Backof-the
House are value-added activities. Non-value added activities
include receiving, storing, moving goods, and waiting for processing.
Basically, most non-value added activities consume resources without
adding value to the product. Therefore, in order to minimize costs in a
restaurant, such activities should be carefully examined by means of a
PVA approach.
The next phase of applying ABC to a restaurant involved the examination
of the general ledger and the assignment of overhead costs
Raab, Shoemaker, and Mayer 7
TABLE 2. Activity Dictionary (Front-of-the-House)
Main Activities Description
Communicating Taking orders, interaction with customers, greeting customers, explain
menu, sell menu items, taking reservations, answering phones,
checking on guest satisfaction, seating people, communicating
between bussers, management and servers.
Cleaning Keeping menus in order, cleaning floors, maintaining tables, and
cleaning ashtrays.
Set-up Folding napkins, polishing silver, dining room set up (set tables, side
station), making coffee, processing checks, process orders, (inputting
into the Point-of-Sales System), close tabs.
Serving customers Serve water, pick up orders, serve meals, time orders, bringing
condiments to table, replacing cutlery, present check, collect
payment, and make change,
Administrating Supervision, forecasting, scheduling, and training.
TABLE 1. Activity Dictionary (Back-of-the-House)
Main Activities Description
Cleaning Dish-washing, disinfecting, cleaning floors, washing pots, refill soap hand
wash stations, cleaning walls, counters, hoods, staff bathrooms, refrigerators,
storage, beverage machines, removing trash, and washing hands.
Preparation Selecting, washing, cutting fruit and vegetables, defrosting, pre-portioning,
sauces and soups, cutting meat, grinding meat, mixing ingredients, and
line set-up.
Cooking Preparing hot meals, expediting, read orders and time orders, dish out
soup, cook sides, fry meat and seafood, arrange items on plate and
garnish, keep food warm, preparing salad, put together ingredients,
preparing desserts, cut cake and dish ice cream, whip cream, bake,
broil, blanch, stewing and, plate set-up.
Administrating Purchasing, budgeting, supervising, menu research, create menus and
items, scheduling, training staff, receiving, storing, and forecasting.
into homogeneous cost pools. According to the Uniform System of
Accounts for Restaurants, overhead costs include the following items:
(1) Salaries and Wages; (2) Employee Benefits; (3) Direct Operating
Expenses; (4) Music and Entertainment; (5) Marketing; (6) Utility Service;
(7) General and Administrative Expenses; and, (8) Repair and
Maintenance Expenses (Schmidgall, 1997). Homogeneous cost pools
are a collection of overhead costs for which cost variations can be
explained by only one first stage cost driver and that share a common
purpose in the operation of the facility. An example of a first stage cost
driver is the number of hours worked by the employees. This first stage
cost driver is applicable to all labor related overhead costs.
Working with restaurant management and following the model guidelines
(Figure 1), three separate cost pools were created?labor, direct
operating supplies, and facility sustaining. The first two cost pools contained
overhead costs that were directly traceable to individual menu
items. On the other hand, the facility sustaining cost pool contained all
other overhead costs for which no first stage cost driver could be identified.
Therefore, no cost driver rates were established for this cost pool.
Next, the labor and direct operating supplies cost pools were divided by
the number of cost driver units, which established a cost driver rate for
each of them. These pool rates were later applied as an internal costing
mechanism for the dinner entr?es, to reflect the cost of resources they
consumed at each activity level.
The next step of an ABC process divides each activity center into a
second stage, and establishes ?second stage? cost drivers by dividing
the total costs of each activity center into activity cost driver pools.
According to ABC theory, all activities have a hierarchy, and cost drivers
enable the activities to be grouped into different levels, such as unitbased,
batch-related, product-related, or facility sustaining (Cooper,
1990; Turney, 1991; O?Guin, 1991; Garrison & Noreen, 1997).
Thus, there are four categories of second stage cost drivers applicable
to the restaurant industry. The first is unit cost drivers, which occur anytime
a unit is produced and are directly related to the number of units
produced. The number of employee hours and units of utilities used are
unit-based cost drivers applicable to the restaurant industry. The second
category, batch cost drivers, incorporate everything that is produced in
batches such as setting up the kitchen line or purchasing inventory. The
third category, product level drivers, signify resources used by productlevel
activities that are performed to sustain products in the company?s
product line. In a restaurant, some examples of product-level activities
include establishing and maintaining specifications, recipe testing, and
8 International Journal of Hospitality & Tourism Administration
expediting food production. Finally, the facility sustaining cost driver
category contains costs that sustain a company?s general processes such
as accounting, marketing, property taxes, security and landscaping.
According to ABC theory, each of the activity cost driver pools has
its cost assigned to products using a second stage cost driver that is unique
to each cost pool. A cost driver pool is distributed to products based on
the number of cost driver units it consumes. The overhead cost applied
to the product is calculated by multiplying the number of cost driver
units with the cost pool rates established during the first stage of an
ABC process. Finally, ABC costs that were calculated for each entree
were condensed as bills of activity. A completed bill of activity becomes
a powerful tool for analysis and subsequent action by restaurant management.
An example of a completed bill of activity that resulted from
this study for a dinner entr?e (Pasta Marinara) is presented in Table 3.
Since the restaurant involved in this study operated at a loss, all overhead
costs were a major source of concern by management. However,
similar to most restaurant operations, labor and related costs represented
by far the greatest source of concern to management. Therefore,
the main objective for the study became the ability to trace labor and
related costs to each entr?e. In addition, management also wanted to
trace all direct operating supplies to individual dinner menu items.
Thus, three cost pools were established along these lines: (1) A ?Personnel?
cost pool, which included all salaries, overtime pay, and wages for
temporary help, all employer taxes, worker compensation expenses,
employer insurance, and employee meal accounts; (2) a ?Direct Operating
Supplies? cost pool, incorporating the uniform and laundry account
as well as the disposable supplies account; and (3) a ?Facility Sustaining?
cost pool, including the utility, repair and maintenance, accounting,
general and administrative expenses, insurance, security, landscaping,
telephone, marketing, travel and entertainment, and equipment depreciation
accounts.
Next, the three cost pools were assigned to the two activity centers
(FOH and BOH) and cost pool rates were calculated. Table 4 displays
the results of this process for the first two cost pools, including their associated
cost pool rates. Table 4 does not display the facility sustaining
cost pool because according to the ABC literature, cost pool rates can
only be calculated from cost pools that can be traced to individual menu
items (O?Guin, 1991; Garrison & Noreen, 1997). Instead, an allocation
value was established for the facility sustaining cost pool based on the
number of dinner entrees that were sold during the month of November
2003. This approach for these costs is consistent with ABC theory in
Raab, Shoemaker, and Mayer 9
manufacturing, which ultimately allocates a portion of the total overhead
costs that cannot be traced to individual items. All figures shown
in Table 4 were obtained from the restaurant?s general ledger for
November 2003, which was provided by restaurant management. Both
activity centers were then divided into cost driver pools and levels of
activities were established.
10 International Journal of Hospitality & Tourism Administration
TABLE 3. Completed Bill of Activity for Pasta Marinara Entr?e
Activities Resources
Used
Cost Pool Rates
($/Minute)
Total Cost $
Unit-Level Activities?FOH
Communicating 1.20 minutes 0.39 0.47
Setting-up 1.00 minutes 0.39 0.39
Serving customers 1.00 minutes 0.39 0.39
Processing checks 1.45 minutes 0.39 0.56
Total 4.65 minutes 1.81
Unit Level Activities?BOH
Preparation 2.0 minutes 0.17 0.34
Cooking 2.0 minutes 0.17 0.34
Cleaning 1.0 minutes 0.17 0.17
Total 5.0 minutes 0.85
Total unit-level activities 9.65 minutes 2.66
Batch-Level Activities?FOH
Setting-up 3.20 minutes 0.39 1.25
Cleaning 1.59 minutes 0.39 0.62
Administrating 3.83 minutes 0.39 1.49
Total 8.62 minutes 3.36
Batch-Level Activities?BOH
Preparation 6.13 minutes 0.17 1.04
Cleaning 5.55 minutes 0.17 0.94
Total 11.68 minutes 1.98
Total batch-level activities 20.30 minuts 5.29
Product-Sustaining Activities
FOH?Administrating 2.55 minutes 0.39 0.99
BOH?Administrating 3.21 minutes 0.17 0.55
Total Product-Sustaining Activities 5.76 1.54
Facility-sustaining activities 1 unit 5.29
Direct operating costs 4.97 percent 0.26 1.29
Food costs 1 unit 2.00
Total cost 18.07
Observation and interview methods were employed to identify second
stage cost drivers and activity hierarchies, which divided the two
activity centers into unit-level, batch-level, product-related, and facility
sustaining cost pools. Basic second stage cost drivers for unit-level activities
were identified as time spent on activities conducted each time a
customer is served and an entr?e is produced. General cost drivers for
batch-level activities were the number of batches required, such as
number of set-ups per day, or the number of times purchasing and receiving
is needed during the month. Major product-sustaining cost drivers
were identified as the number of new menu items created each
month and the number of new employees hired per month. The results
of the ABC process became a completed bill of activity for each menu
entr?e (Table 3), which allowed restaurant management to truly understand
the cost structure of its menu for the first time.
DISCUSSION
The ABC approach described in this study revealed that the dinner
menu, which contained fourteen individual entr?es, was the major
contributor to the restaurant?s negative operating profit. This result
reflects the restaurant?s relatively high overhead costs, and particularly
its high labor costs. In this case, the entr?es? actual costs were higher
than the restaurant?s menu prices, if analyzed using ABC methods.
Therefore, every time a dinner entr?e was sold, with the exception of
Raab, Shoemaker, and Mayer 11
TABLE 4. Cost Pool Rates
Activity Centers Personnel Direct Operating Supplies
FOH $23.60/hour
($11,545/489 hours)
$0.26/entr?e
($218.24/828 units consumed)
FOH cost pool rate
calculations
Total labor cost/hours worked Total direct operating costs/units
used
BOH $10.22/hour
($4686.75/458.50 hours)
$0.26/entr?e
($509.23/1932 units consumed)
BOH cost pool rate
calculations
Total labor cost/hours worked Total direct operating
costs/units used
Note: All figures shown in the table were obtained from restaurant management for the month of November
2003; for example, the hours used came from the restaurant?s payroll records, and the units consumed represent
actual supplies that were used during the month.
three entrees that could be classified as very profitable, the restaurant
suffered an operating loss.
In addition, the analysis of the general ledger cost pools provided
some compelling insights. First, the separation of overhead costs into
homogenous cost pools and their assignment to the FOH and BOH activity
centers revealed where major costs occurred with far more precision.
For example, for the dinner shift observed in this study, the FOH
incurred 61 percent of the overhead costs; of that figure, the FOH ?Personnel?
cost pool represented over half (53 percent) of all overhead
costs. The detailed analysis of labor costs and hours necessary to establish
the ?Personnel? cost pool and a cost pool rate identified that the
hourly wages paid at the restaurant involved in this study are much
higher than restaurants traditionally pay for their labor.
In addition, the analysis showed that the BOH incurred overtime hours
for 53 percent of all hours worked. The use of part-time employees and
more sophisticated demand forecasting methods are some likely solutions
that could result in the reduction of overtime hours for this establishment.
Another opportunity for management to reduce FOH labor costs arises
from the use of PVA to reduce and eliminate any non-value added activities.
For example, in the restaurant involved in this study, approximately
one-half of all the existing activities in the BOH and FOH are consuming
resources without directly assisting in producing products or providing
service to the customer. This seems much too great a commitment to
non-value added activities. Therefore, management should review all
non-value added activities and use this information to improve the establishment?s
processes. Some of the non-value added activities that were
identified should be eliminated, such as personal conversations and extensive
personal phone calls. Other non-value added activities could be
candidates for outsourcing. For example, non-value added food preparation
activities in the BOH could be reduced if pre-cut and pre-washed
produce is purchased and meat and fish product are purchased already
portioned. Finally, it may be advisable to outsource some of the cleaning
activities such as the cleaning of hoods, walls and restrooms. Even
though these actions may be considered common sense for a restaurant
manager, the significance these insights might not have been identified if
the restaurant had not been subjected to an ABC analysis.
These insights are consistent with the thrust of ABC applications in
the business literature, which suggest that if products consume diverse
amounts of resources, the ABC method will reveal dramatically different
product costs in comparison to product cost methods that are based solely
on contribution margins (Cooper, 1989). Indeed, this study revealed that
12 International Journal of Hospitality & Tourism Administration
overhead costs were consumed at a diverse resource consumption rate
by each entr?e.
IMPLICATIONS AND LIMITATIONS
This study demonstrated that ABC methods can be successfully
applied to a restaurant. The ABC model that was developed in this study
can be applied to virtually any full-service restaurant, but the results of
such a study would likely be different from this one, depending upon the
market characteristics and cost structure of that particular restaurant.
Nevertheless, applying ABC methods can assist to restaurant operators
in a number of ways. First, ABC can enhance restaurant feasibility analysis
by making menu planning more accurate relative to individual item
profitability. Second, ABC methods can help a restaurant identify
which menu items are truly profitable and which ones are not, given the
restaurant?s customer profile. Third, ABC methods can assist in evaluating
promotions, such as the decision to use a price discount on a featured
item to boost sales; ABC can help determine whether that decision
will incur a profit or loss for the promotion.
Although it is only a single case study of a restaurant, the findings indicate
that restaurant managers should make menu decisions using more
complete cost information. It also suggests that applications of menu
profitability analyses that go beyond the simple analysis of food costs
may be very appropriate for a restaurant. Restaurant managers can make
much more reliable decisions with complete cost information, which
emphasizes the need to calculate ABC costs for each item on the menu.
Furthermore, this study supports Cooper?s (1989) view that the lack
of precise product overhead costs may totally distort total product cost
and price, which was the case for this restaurant. Thus, it is likely that a
restaurant manager?s menu management decisions will differ dramatically
if he or she is confronted with differing results from a contribution
margin or an ABC approach. Of course, many other factors besides cost
also enter into menu pricing decisions, such as customer perceptions of
value and quality, customer segmentation, and competition.
This study contains a number of limitations that should be noted.
First, although the ABC model that was developed could be applied to
other full-service restaurants, the specific findings of this study cannot
be generalized to the restaurant industry as a whole, or to other restaurant
types, without further research. Second, this study only examined the
restaurant?s dinner entrees; the restaurant?s beverage service and its
Raab, Shoemaker, and Mayer 13
lunch menu were not included herein. Thus, no conclusions can be
drawn about the restaurant?s situation on an overall basis since a complete
ABC analysis of all food and beverage items was not done.
SUMMARY
This study was able to develop and apply a workable ABC model for
a restaurant, which established a unique overhead cost value for each
menu item. This process allowed for the calculation of bills of activities
for all entr?es, which included both the overhead costs and food cost per
entr?e. Therefore, this study was able not only to assign accurate overhead
rates, but also to provide true product cost information for the restaurant
in the form of operating profit margins for each entr?e. It
suggests that ABC methods can be applied in the restaurant industry,
and may allow for greatly improved financial analyses that incorporate
more precise and complete cost information. Thus, the study revealed
that the application of ABC methods to restaurants is not only feasible,
but also highly informative.
Future research on this topic should include determining whether ABC
methods can be applied to other restaurant types, such as buffet, quick
service, or casual dining venues. In addition, the ABC analysis should incorporate
all meal periods in a restaurant, so that an overall picture of the
operation can be determined. Further, the potential application of ABC
methods to other hospitality sectors, such as hotels, spas, or casinos,
should be investigated. Finally, it would also be beneficial to conduct a
study that combines ABC with a price sensitivity analysis, which would
incorporate both costing and pricing aspects of a hospitality operation.
REFERENCES
American Express (2003). Unpublished study cited in the NBC television show: The
Restaurant.
Bell, D. (2002). Food & Beverage Cost Control?Course Packet. Las Vegas: University
of Nevada, Las Vegas, Department of Reprographic Services.
Cardinaels, E., Roodhooft, F. & Warlop, L. (2004). The Value of Activity-Based Costing
in Competitive Pricing Decisions, Journal of Management Accounting Research,
l6(1), 133-148.
Chan, W. & Au, N. (1998). Profit Measurement of Menu Items, Cornell Hotel and
Restaurant Administration Quarterly, 39(2), 70-75.
Cokins, G. (2001). Activity-Based Cost Management: An Executive Guide, NY: John
Wiley & Sons, Inc.
14 International Journal of Hospitality & Tourism Administration
Cooper, R. (1989). The Rise of Activity-Based Costing?Part 4: What Do ActivityBased
Cost Systems Look Like? Journal of Cost Management, Spring, 38-49.
Cooper, R. (1990). Cost Classification in Unit Based and Activity-Based Manufacturing
Costs Systems, Journal of Cost Management, 4(3), 4-14.
Cooper, R. & Kaplan, R. (1992). Activity-Based Systems: Measuring the Costs of
Resource Usage, Accounting Horizons, 6(3), 1-11.
Daly, J. (2002). Pricing for Profitability: Activity-Based Pricing for Competitive
Advantage, NY: John Wiley & Sons, Inc.
DeFranco, A. & Noriego, P. (2000). Cost Control in the Hospitality Industry, Upper
Saddle River, New Jersey: Prentice Hall.
Garrison, R. & Noreen, E. (1997). Managerial Accounting, 8th ed., NY: Irwin
McGraw-Hill.
Hume, S. (2002). Shape Shifting: In a Downbeat Economy, Top 400 Companies Focus
on Acquisitions, Buyouts and Bankruptcies, Restaurants and Institutions, 112(16),
42-100.
Kaplan, R. & Cooper, R. (1988). Measure Costs Right: No longer. Journal of Management
Accounting Research (Fall), 2-15.
Keller, B. (1994). Activity-Based Costing for the Hotel Industry, [Monograph].
Cornell University.
Kunst, P. & Lemmik, J. (1995). Managing Service Quality. London: Paul Chapman
Publishing Ltd.
National Restaurant Association (2001). Retrieved April 4, 2003 fromwww.restaurant.org
O?Guin, M. (1991). The Complete Guide to Activity-Based Costing, NY: Prentice Hall.
Parsa, H. (2003). Retrieved September 15, 2004 from http://www.researchnews.osu.
edu/archive/restfail.htm.
Quain, E., Sansbury, M. & LeBrutto, S. (1999). Revenue Enhancement, Part 4, Cornell
Hotel and Restaurant Administration Quarterly, 40(3), 38-47.
Raab, C & Mayer, K.J. (2003). Exploring the use of activity based costing in the restaurant
industry, Int’l Journal of Hosp. & Tourism Admin, 4(2) 79-96.
Rotch, W. (1990). Activity-Based Costing in Service Industries, Journal of Cost Management,
Summer, 4-14.
Schmidgall, R. (1997). Hospitality Industry Managerial Accounting, 4th ed., Lansing,
MI: Educational Institute American Hotel & Motel Association.
Turney, P. (1991). Common Cents. The ABC Performance Breakthrough, Cost Technology,
13-17.
Wilke, E., Josiam, B., Upchurch, R. & Willems, J. (1996). Restaurant Attrition: A Longitudinal
Analysis of Restaurant Failures, International Journal of Contemporary
Hospitality Management, 8(2), 17-20.
Zeithaml, V. & Bitner, M. (2003). Services Marketing: Integrating Customer Focus
Accross the Firm, 3rd ed., New York: McGraw Hill.
RECEIVED: 10/08/05
REVISIONS RECEIVED: 12/29/05
ACCEPTED: 01/17/06
doi:10.1300/J149v08n03_01
Raab, Shoemaker, and Mayer 15

Quiz 4
Names:
Read chapter 5 and answer questions 1 ? 7 (10 points each) and read the attached article to answer question 8 (30 points). Bring your answers to class on Tuesday October 25.

1. If a bartender can somehow accumulate extra liquor, and does not register the extra drinks, which of these activities could be spotted by the analytical methods we studied?
A. The bartender steals the extra liquor
B. The drinks are given away in hopes the guests will be generous with tips
C. The drinks are sold and the money deposited by the bartender
D. The drinks are sold and the revenue kept by the bartender

2. Which of these controls would be recommended to prevent bar personnel from bring in their own bottles?
1. Par stock
2. Daily inventory
3. Use of lined shot glasses
4. Bottle tags or stickers
5. Use of a perpetual inventory
A. 1, 3, 4
B. 1, 4
C. 2, 4, 5
D. 1, 2

3. If a bartender were overpouring:
A. There would not be a variance between the standard and actual revenue
B. The actual usage would be more than the standard
C. The inventory would show a difference in the par stock
D. The standard cost would be higher than the actual

4. If a bartender was underpouring and not registering the extra drinks (but keeping the extra revenue), which of the following would be true?
A. There would be a variance between the actual and the standard revenue.
B. The actual usage would be higher than the standard usage.
C. There would be no variances in any of the analysis methods we studied
D. The actual percentage would be higher than it should be
E. The actual dollar cost would be less than the standard dollar cost

5. If a bartender were substituting a well scotch for a premium scotch, charging the guest the premium price, and was ringing up the well price; what would your analysis show?
a) The revenue for the premium brand would be low
b) None of these
c) The usage of the premium brand would be excessive
d) The usage of the well brand would be excessive
e) The revenue for the well brand would be low

6. If a bartender brought in his/her own bottle, there is a potential of which of these?
a. The portion sizes can vary
b. Additional drinks
c. Standard portion size larger than the actual
d. Actual revenue less than the standard

7. With a no host bar, the major danger is:
a. Bartenders not pouring standard portions
b. Bartenders padding the catering bill and moving the bottles to the bar
c. Bartenders stealing liquor
d. Bartender stealing cash.

8. (30 points)
Please read the attached article (Activity-Based Costing:
A More Accurate Way to Estimate the Costs for a Restaurant Menu, Raab
Shoemaker and Mayer) and describe the advantages of using Activity-Based Costing (ABC) methods in a restaurant.