A few years ago, I didn’t think we’d make it. Some other agencies and several small restaurants were competing with us, and were undercutting our prices. So a year ago we decided to begin making specialty meals for AIDS and cancer patients, and for other people with special dietary needs. I thought that strategy was working. Certainly sales were up. But now a consultant tells me that our cost accounting system is giving us misleading results, and we may actually be losing money on our specialty meals. On top of that, some of our regular customers are complaining about our prices.

The speaker was George Larson, CEO of Neighborhood Servings (NS), a nonprofit organization that produced and delivered meals to homes throughout the greater Kansas City area. He continued:

I realize that we now need to dig into our costs. We established our prices based on these costs. If the costs for speciality meals are higher than we thought, then our prices are too low, and our whole new strategy is in jeopardy. In addition, if our costs for regular meals are too high, then we’re setting our prices too high and we’ll lose out to the competition even more. Also, we use our cost data for budgeting each year, so if the data are bad, then our budget will be unrealistic.

BACKGROUND

NS had been in business for over ten years. It began as a “meals on wheels” agency, providing dinners to elderly people and individuals who were permanently or temporarily homebound. Almost all of its clients were single and lived alone. Over the years, its menu had expanded, although, based on extensive market research into customer preferences, NS continued to provide its clients with only one meal a day. All meals were sold in “collections” of seven—a different meal for each day of the week, and deliveries (of seven meals each) were made once per week to each client (clients often froze a few of the meals for use in the latter half of the week).

During the past few years, NS had encountered some competition for its services. One or two other nonprofits that had been successful in other parts of either Kansas or Missouri had expanded their operations into the Kansas City area. In addition, some of the local fast-food restaurants, realizing that they could use their kitchen staffs to provide basic fare for delivery to nearby homes, had begun providing meals in certain neighborhoods that were close to their restaurants.

In response, and after considerable debate, NS decided to offer specialty meals. There were two main differences between NS’s specialty meals and its regular meals: (1) specialty meals used a variety of non-standard ingredients, frequently including organically grown fruits and vegetables and often being meatless, and (2) because of a greater need for freshness, specialty meals were delivered daily (one per customer). . . .

Assignment

1. Compute the cost of a regular and special meal using the new overhead pools and cost drivers. What explains the differences between these costs and the ones in Exhibit 1?
2. What is your assessment of the overhead pools and cost drivers that Ms. Canard has chosen? How, if at all, might they be improved?
3. Assuming the overhead pools and cost drivers give a better indication of actual costs, what should Mr. Larson do with this information? In answering this question, you should address the questions he raises at the end of the case.