Financial and Management Accounting

Wendy's, founded in 1968, is facing a strategic decision. In delivering its quality products to customers in company restaurants totalling 288 and franchise operations totalling 1119 in 1978, Wendy's creates waste product in the form of cooked hamburger patties. These patties could be processed further by adding ingredients and minimal labour to create chilli. Two schools of thought exist in determining the profitability of chilli.

Firstly, chilli could be costed by using the full cost (direct cost approach). This would entail costing the waste products as a direct resource for the preparation of chilli, as well as costing the labour used as a direct labour item. Secondly, the chilli could be costed as a byproduct, where the waste received from hamburger production would not be costed by chilli. Similarly, labour would not be costed either as labour involved in production of chilli is small enough not to warrant another employee being employed, and current employee idle time is used.

Irrespective of the costing approach used, Wendy's will increase overall turnover relative to cost by a factor larger than 1 if chilli is introduced on the menu. This indicates to Wendy's that chilli is a profitable menu item and its non-inclusion would result in lower net profits. Background Dave Thomas started his career at a very young age working as a counter boy at a Walgreen's Drug Store. In the subsequent years he worked in several restaurants such as the Regas Restaurant in Knoxville and the Hobby House Restaurant in Fort Wayne, Indiana, learning the basics of restaurants and fast food centers.

His fast food career began in 1956 when he and a friend, Phil Clauss opened a barbecue restaurant in Knoxville, Tennessee. Shortly thereafter, Clauss bought a KFC (Kentucky Fried Chicken) franchise. In 1962, the franchise operations ran into problems and Dave helped Clauss in the turnaround. As a good gesture, Clauss made Dave a 45% partner in the franchise. In 1968, Clauss sold the franchise back to KFC, making both of them millionaires. Dave later joined KFC as a regional operations director. He later worked as a managing operator at Arthur Treacher's Fish & Chips. Capitalizing on his restaurant experience, Dave started Wendy's in 1969 in Columbus, Ohio, naming the company after his daughter Melinda Lou (known in the family as Wendy), so that the restaurant would sound like a family business.

Dave wanted to offer a dining experience different from that of McDonald's, Burger King and several other small operators. His goal was to provide customers with bigger and better hamburgers that were cooked to order, served quickly, and reasonably priced. During this time, most chains concentrated mainly on the children (kids and teenagers) and had neglected the adults and young adults. In doing so, Dave did not view Wendy's as just another hamburger chain. He believed that the adults looked for improved taste in the hamburgers and an upscale restaurant ambience. Hence, he decorated the restaurant with carpeting, wood paneling, and lamps.

Wendy's mission statement was the cornerstone of its long-term operating strategy-deliver total quality with great food, excellent service, competitive prices, and a sparkling atmosphere for each customer. The preparation and frying of the patties for both hamburgers and chilli is precisely similar. It is only when the patty is taken from the fryer that a distinction is made. A specific split-off point is therefore in existence. With the computation on a by product basis, a similar computation to that of direct costs would result, with the exception that certain direct resource costs are excluded and direct labour costs are excluded as a whole.

The computation for direct resources could be depicted as follows: Note that, when computing the addition of beef for the by-product, ONLY the beef that is fried specifically for the production of chilli is included. The assumption is made that the 10% as given relates to a yearly occurrence. The remaining 10.8 pounds of beef required per batch is received from the production of hamburgers and is regarded as a cost (spillage) for the hamburgers 

The computation of direct labour is shown as follows: On a full cost basis and assuming the assistant manager and the crewmember share responsibilities equally, the cost is approximately $0.02 per serving of chilli. This takes into account the fact that patties are only fried specifically for chilli 10% of the time. In computing the labour involved, time spent by employees monitoring the simmering chilli was assumed to be immaterial. 

For the determination of labour costs on a by-product basis, the question begs the answer to: "The assistant manager and crew member are on site and are being paid at different hourly rates. They are not being paid additionally for the labour necessary in the production of the chilli and their pay package is not output driven. What are the labour costs to be attributed then to the production of chilli in this instance?". The following rough estimate of time spent on producing chilli is shown:

Roughly, 21 minutes are spent daily on producing chilli. With the immateriality of this figure it could be said that employee idle time are spent on producing the chilli. It is possible to determine that the amount of labour to be attributed to chilli as by-product is $0.00 due to the following factors:Wendy's are the only company that could use the excess beef - competitors used pre-cooked frozen patties that could not be processed into any other product. It is therefore evident that Wendy's should not drop chilli from its menu and should instead embark on a marketing drive to try and increase the sale of chilli.