In his analysis of the cost of selling peanuts, the expert included every expense from the wholesale cost of the nuts to the salary of the cook. However, when considering overhead the standard is not to incorporate and distribute all operation costs equally across the operation base expenses of the business but to allocate costs to each particular segment of the business in appropriate proportions. Therefore, in Joe’s situation it is appropriate to allocate a percentage of the general operations costs such as rent, utilities, building maintenance and sales staff. The kitchen that prepares the food and the expenses related to it are an entity to themselves and cannot be justifiably included in the cost of peanut sales. The cook’s salary, the servers’ salaries and the cost of operating the kitchen have nothing to do with the sale of peanuts, and should not be included in the expenses for the sale of peanuts.
On the other hand a portion of Joe’s salary should be included as well as an appropriate percentage of business expenses like the washroom soap, rent, utilities and even the free cokes to the police officers. However, since the food is the big draw for the establishment, and a profit generator in itself, it is appropriate for that business segment to assume a larger percentage relative to the volume of transactions than the peanut operation. To use a larger company as an example an insurance company maintains a central corporate office, this provides support to a number of branch offices. It is appropriate for each branch office to assume a portion of the expense of maintaining the central corporate location. However, branch office “A” should not be responsible for the expenses of branch office “B” and vice versa.
The expert is correct in that the portion of counter space used by peanut sales should be attributed solely to the sale of peanuts. In that instance the $1,250 per year attributed to peanut sales should be taken off the food operation balance sheet and added to the peanut sales balance sheet, along with the rack. This is a fixed cost and Joe is correct that increasing the volume of peanut sales will lower the cost of this overhead. Therefore, the more nuts he sells the lower the cost of overhead per bag and the higher the profitability of the peanut operation. The wholesale cost of the nuts is a constant amount per sale and must be calculated differently.
Another consideration is that some customers may choose Joe’s establishment over his competition because so they can get nuts to go along with their sandwiches. In that event, the nuts have an added, almost incalculable value. Another consideration is the peanuts are occupying what was previously “dead space.” Since they did not displace another potential source of income, they can be view as an added asset. As a bottom line, it looks as though Joe’s peanut sales person was more correct than the “expert” was although neither is completely right. The peanuts are potentially profitable, just not as much as the salesperson predicted.