Term Project Accounting

(Assignment 2)

Break even analysis for Guesthouse

facility

Group:
Kasturi Durga Babu (2018SMF6608)
Gokulkrishnan S (2018SMT6597)
Sai Chandra Nakka (2018SMF6584)
Shiva Kumar Angirga (2018SMF6592)
Executive Summary:

Case: ILP is an educational institution in Hauz khas seeking to run a guest house facility at no-
profit-loss basis for its guests who visit the campus for various campus related activities. The project
estimates split-up of various cost involved in running a guest house facility and estimations on what
need to be charged per day from each guest using the room so institution achieves break even.

The following are the assumptions for the case:

1. No of rooms available = 40
2. Guest houses are open throughout the year
3. All rooms are homogeneous with equal facilities
4. Amenities are common to all rooms and not individual
5. No significant changes in taxes for this business
6. July and September have highest occupancy due to Joining in July and Fest in September
7. December and June have lowest occupancy due to holidays and extreme temperatures.

The method used is activity-based costing which involved accounting for various activities
involved in running the guesthouse, human management and resources provided. Average
occupancy in a year is projected at 74.16% ( Table 1) and calculations are divided into three parts:

1. Direct material – Cost involved in raw materials requires for running guesthouse(Table 2)
2. Direct labour – Cost involved to maintain human resource (Table 3)
3. Overheads- Cost that are irrespective of number of guest visiting the institution.
( Table 4)

The allocations to each are shown in table form and the split up is Direct material cost
involved is 36.5lpa, direct labour cost is 61lpa and overheads cost is 25.6lpa with total amounting to
1.23 crores per annum.

To achieve break even the formula used is:

Number of rooms used per year = Number of rooms*365 days* occupancy rate

Total cost per year = direct cost + indirect cost

Break even = Total cost / total number of rooms used per year
Introduction:

ILP is an educational institution based in House Khas, on plans to avail guest house facility to
guest visiting the campus on campus related activities. The report estimates the cost that
ILP(Educational Institution in Hauz Khas) should charge its guests for availing guest house facilities.
Institute seeks to provide this facility at break-even so that guest can get the room at minimum cost
incurring no loss to institute.

Following are assumption in the case:

1. Number of rooms available = 40

2. Infrastructure is already established and no further money to be put in building infra.
3. Guest houses are open throughout the year and staff will and resources are costed
throughout the run of guest house.
4. All rooms are homogeneous with equal facilities.
5. Amenities are common to all rooms and not per individual.
6. No significant changes in taxes for this business in the near future.
7. July and September have highest occupancy due to Joining of new students or visit of
parents in July and increased guest for Fest in September
8. December and June have lowest occupancy due to holidays and extreme temperatures.

Building Infrastructure & Features provided:

Building has 40 rooms each at 30sqm, parking space and conference room. Each guest is provided
with basic amenities which are accounted under direct materials cost as mentioned in Table 5.

Theory:

Activity based costing:

Activity based costing assigns cost for each activity involved in running the organisation or business
rather than on time-estimates of running business. Activity based Costing is preferred estimation of
cost as it is accurate and good cost control. The accounting method categorizes the activities that the
guest house performs and then assigns indirect costs to services.

Activity based costing involves four steps:

(1) identifying the major activities that take place in guest house facilities;
(2) allocating costs to cost centre for each activity;
(3) fixing the cost driver for each major activity; and

(4) Allocating the cost of activities to services and customers

In using the ABC method for costing, we have to identify the main activities and then
recognize the allocation base for each activity. We considered three main cost centres which are as
follows:
(1) Housekeeping,
(2) Administrative and Accounting,
(3) Technical and engineering.

Among these cost centres, housekeeping is operational; and administrative and accounting, and
technical and engineering, are non-operational costs. The operational costs are directly related to
services provided for guests, and non-operational costs cannot be directly traced to those services.

There are four different types of costs which occur regarding to all activities, as follows:
1. Payroll costs
2. Raw material costs
3. Maintenance costs
4. Other costs

The cost structure which we considered included following:

1- Direct material
2- Direct labour
3- Overhead cost

ILP Guest house Infrastructure

The Guest house building has 3 floors and a basement for parking. The group floor contains
Reception, Conference room, Restaurant and Kitchen and first and second floor contains twenty
rooms each. Each room is of standard industrial standard size (30 sqm) and is equipped with all
essential facilities. The restaurant and kitchen is leased out to a third party vendor and zero rent is
taken so as to ensure the occupants will have access to service of the restaurant at a minimal cost.

Expected Customers

The customers expected to use the facilities are assumed to be visiting faculty, dignitaries visiting the
campus for attending or organising different conclaves and sessions, industry representatives visiting
the campus for placement related activities, faculty and students visiting from other IITs, alumni
students visiting the campus, kith and kin of IIT faculty and parents or relatives of student resident in
the campus. The extend of stay will depend on the nature of visit but for the convenience of our
calculations we have assumed that there will be no discounts or rebates for extended stay and room
charges will be fixed through out the year. There shall also be no concessions for different category
of occupants. IIT faculty, Students or Alumni will have no special concessions over other visitors in
the campus. There will online booking facility open to general public, but allotment of rooms will
only be done on submission documents pertaining to need of accommodation via online or offline.
Allotment of rooms will only be done subject to approval by competent authority (in this case
manager if the guest house) after verification of request submitted. The cost of maintaining an
online booking portal is shown under the Technical and Engineering cost head under the subdivision
maintenance cost.

Room Occupancy

The guest house boasts 40 standard rooms equipped with all basic and some luxury facilities. Since
the guest house will be chiefly occupied by occupants who are in some way affiliated to IIT Delhi the
number and frequency of request for accommodation will also depend on the calendar of IIT. For
example during the annual tech fest of IIT there will be a huge rush of requests coming in for
allotment of guest house facilities from different parts of the country and contrastingly the facilities
will be sparingly in demand during the winter break as the campus would be more or less in holiday.

An accommodation facility in India has an average occupancy rate of 70% (ref no.7) and in case of an
IIT guest house its impractical to adopt such a statistic for calculation because the guest house aims
to provide service only to a niche segment of customers. Hence a unique method of calculation of
average occupancy is inculcated with mainly uses inputs from IIT academic calendar. Important
events occurring in the campus like National level tech fest, Convocation, Winter and Summer
breaks etc have been taken into consideration for formulating a projected monthly occupancy rate.
From these number an average occupancy rate is calculated for the year and this value is used for
calculation of per room rent for a day to achieve break even.

De Ja
Months Apr May Jun Jul Aug Sep Oct Nov c n Feb Mar Avg
%
occupanc 10 10
y 60 80 40 0 80 0 60 90 40 80 90 70 74.167
Rooms
Occupied 24 32 16 40 32 40 24 36 16 32 36 28 30
120
100
80
60
40
20
0
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Avg

Methodology Applied - Activity Based Costing

Activity based costing involves four steps:

1. Identifying the major activities that take place in guest house facilities
2. Allocating costs to cost center for each activity
3. Fixing the cost driver for each major activity
4. Allocating the cost of activities to services and customers

The cost structure which considered includes the following:

1. Direct Cost
2. Indirect Cost - Overhead cost

Direct Costs

A direct cost is a price that can be completely attributed to the production of specific goods or
services. The costs involved directly in the running and functioning of the guest house can be
classified into two categories:-
 1. Direct Labour Cost
2. Direct Material Cost

Direct Labour Cost

The guest house facility employs 21 full time employs since the restaurant functioning in the facility
is leased out its employees are not considered in calculating direct labour cost. The employees are
paid basic salary and other allowances and benefits which are slightly above industrial standards as
the guest house aspires to have a premium tag being affiliated to a premium institute. The guest
house pays a higher salary and expects its employees to reciprocate with higher standards of service
for its occupants. The salary and allowance split up is not carried out in the calculation of direct
labour cost in which only the gross salary of employees is shown. The manager is the most valued
and consequently most rewarded among employees drawing a gross salary of 10 lakhs per annum.
To assist the manager two administrative staff are employed each drawing a gross salary of 6 lakhs
per annum. Twenty four hour service is ensured in the front desk (reception) for the occupants and
to that end three front desk employees each with eight working hours per day is assigned and every
front desk staff draws a gross salary of 4 lakhs per annum. House keeping forms the largest
department (directly supervised by the manager) and is equipped with 8 staff member each drawing
a gross salary of 1.5 lakhs per annum. Other staff employed in the guest house include 2 security
guards each drawing a gross salary of 2 lakhs per annum, 2 supplies and storage staff each drawing a
gross salary of 2.5 lakhs per annum, 2 technical aid staff each drawing a salary of 2 lakhs per annum,
1 maintenance staff drawing a gross salary of 2 lakhs per annum specifically allotted for the
maintenance and upkeep of the conference room facility available to the occupants of the guest
house.

Numbe Original Salary per Total pay for

Department r s year(lpa) each(lpa)
Management 1 3 10 10
Administrative and
accounting 2 5 6 12
Supplies and storage 2 2 2.5 5
Front desk 3 9 4 12
Security guard 2 5 2 4
Technical staff 2 5 2 4
House keeping 8 18 1.5 12
Conference room 1 3 2 2
Total pay 61
 Conference room House keeping
Direct Labour cost(LPA) Technical staff Security guard
Front desk Supplies and storage
Adminstrative and Management
accounting

0 4 8 12

A total of 61 lakhs is the cost incurred by direct labour.

Direct material Cost

Material costs involved are mainly derived from room upkeep and maintenance materials, Other
Infrastructure maintenance material, Administration aid materials etc. The complete list of material
expenses incurred in a financial year under various heads are listed in the following table: -

Purchasing
Inventory Quantity Price Total
Towels expenses 1440 200 288000
Sheets expenses 1440 150 216000
Facecloth expenses 1440 100 144000
Pillow expenses 1440 100 144000
Blankets expenses 1440 200 288000
Newspaper expenses 12 2000 24000
Coffee expenses 2880 40 115200
Toilet requisites expenses 960 200 192000
Flowers expenses 480 200 96000
Brooms expenses 120 200 24000
Soaps and polishes expenses 960 300 288000
Cleaning chemicals expenses 960 500 480000
Mops expenses 960 200 192000
Brushes expenses 960 200 192000
Cleaning accessories expense 960 500 480000
Pencils and Pens expenses 480 500 240000
Desk pad expenses 480 500 240000
Total Expenses 3643200

A sum total of 36.432 lakhs is incurred resultant of various expenses under the direct material cost
head.

Indirect Costs or Overhead Costs

Indirect costs go beyond the expenses associated with creating a particular product to include the
price of maintaining the entire company. Overhead costs in the guest house has been differentiated
into various expenses such as utility expenses, Insurance premium, facility maintenance expense etc.

The rooms in the guest house is standardized and is equipped with air conditioners and geysers
which are essentials owing to the specific climatic conditions of Delhi. Hence the electricity bill is
calculated to be a bit on the higher side. Water charges and internet charges are standardized to
industrial reference. The complete table listing out all the overhead costs is given below: -

Over head of 2018 Per month Per Year(lpa)

Water bill 10,000 1.2
Electricity bill 50,000 6
Internet bill 10,000 1.2
Drinking water 15,000 1.8
Insurance 2
Facility Maintenance 1,00,000 12
Other 1.4
Total 25.6

A total of 25.6 lakhs is incurred in the financial year as in directed cost.

Cost Centres:

There is several cost centres involved in activity based costing. The total cost that is involved in cost
structure that is direct material, direct labour, overhead costs and other costs and there are several
sub divisions of these costs that are involved like discussed above. Now the total cost can be actually
driven by several cost centres those are Housekeeping, Restaurant, administrative and accounting
and Technical and engineering.

There is sub division of cost centre activities those involve payroll, raw materials, maintenance,
miscellaneous and other costs. These sub divisions are part of all cost centres.

In cost centre of house keeping in sub division of payroll the direct labour costs of suppliers and
storage, housekeeping, conference room staff will be involved an the cost of these payroll will be 19
lakhs. In the same manner the labour cost involved with payroll activities will be divided out of 61
lakhs to the all cost centres.

The raw material cleaning expenses, decorating expenses, amenities expenses, room expenses
coffee, flower and linen expenses these direct cost will be sub divided depending on the material
among the cost centres the division 20 lakhs, 10lakhs, 5lakhs.

In the similar manned the cost involved with maintenance of rooms, guest house , plumber,
painting, rework things these all will divided among maintenance. The other costs which are small
contribution also recorded as other costs in cost centres.

The entire cost centre structure and the cost division among them can be seen in the table below
table.
Overhead cost table (all the price are mentioned in lakhs)

House Keeping Category Price

Payroll 19
Raw
material 20
Maintenanc
e 17
Other Costs 0.8
Total cost 56.8
Administrative and accounting
Payroll 34
Raw
material 10
Maintenanc
e 3.2
Other Costs 0.2
Total cost 47.4
Technical and engineering
Payroll 8
Raw
material 5
Maintenanc
e 5
Other Costs 0.4
Total cost 18.4

Cost Calculation:

We are following traditional cost mixed with activity based costing approach for its benefit of ease of
calculating and ease of use. The points which are considering for this costing is calculating the costs
involved with direct cost, indirect cost fixed and variable cost and the costs involved in overhead
costs. We calculated the total cost incurred by all these and we used the occupancy rate of 74.167 %
as per table to get the number of rooms that are actually using overall in a year.

The calculations involve that 40 rooms are using for 365 days with an average of 74.167 % occupancy
rate that gives the number of rooms occupied in a year that is 10828 rooms as per table. the total
cost incurred to us as calculated above is 123.1 lakhs. That gives us the cost per each room in a
guest house to be 1136.8 rupees without imposing tax.

The breakeven point that is nothing but no profit and no loss will occur if we can map the expenses
with revenue. The expenses that can occur are calculated and the revenue is room rent charges paid
by the customer.

With the cost in hand that is 1136. 8 rupees we add GST of 12 % as per reference the cost on
customer increased to 1274 rupees at a break even.
The total calculations and the division of cost are can be seen in table.

Category Prices
Direct labour 61lakhs
Direct material 36.5lakhs
Over heads 25.6lakhs
123.1lakh
Total Cost s
Number of room occupancy
days 10828.3
Rent before GST 0.01137
Rent(excluding food) 1273.22

The assumption here in pricing strategy is we outsourced the restaurant to outsiders without any
profit but with a limitation of that they are going to provide the food on a minimum price with high
quality. So in the cost centre, restaurant will not be visible in any of our calculations.

Improvements ILP can do to reduce cost of maintenance

Inferences from the calculations:

COST STRUCTURE

Over heads
21%

Direct labor
50%
Direct material
30%

49 % of the expense that is 61 lakhs are occurring that due to direct labour only
 Cost Center Expenses
House Keeping Administrative and accounting
Technical and engineering

15%

46%

39%

46 % of expenses of cost centre are occurring via housekeeping that is 56.8 lakhs. And 39% that is
47.4 lakhs is by administrative and accounting.

The focus areas are optimization of direct labour and reducing expenses in the all cost centres. To
optimize the labour we can follow a strategy such that there will fixed number of labour that can
serve to minimum occupancy and we can keep the other labour as variable. We should go with
alliance with local labour supply companies to meet the peak demand of occupancy in July and
September.

The next strategy is following variable pricing strategy such that the price will be low in the months
of June and December and high in the months of July and September depending on the occupancy
rate. So that it will be ease of maintenance and reduce the cost for customer.

For the operations, and direct material involved in housekeeping and administrative we have to form
long term contracts so that we will get the material at a low price without compromising on the
quality.
References:

https://waset.org/publications/10007835/activity-based-costing-in-the-hospitality-industry-a-case-
study-in-a-hotel

https://www.researchgate.net/publication/228300900_Activity-
Based_Costing_in_the_Hospitality_Industry_Evidence_From_Greece

https://www.scribd.com/doc/115477737/Applicability-of-Activity-based-Costing-in-Services-Case-
study-in-a-hotel

https://economictimes.indiatimes.com/industry/services/hotels-/-restaurants/declared-tariff-for-
gst-foxes-hotels/articleshow/61991139.cms

http://chafra.bilkent.edu.tr/Hia/Chapter%2002.doc

https://www.statista.com/statistics/723534/hotel-occupancy-rate-in-delhi-india/

https://www.investopedia.com/terms/d/directcost.asp#ixzz5VgEvRFN3