Cost Accounting Analysis of Krispy Kreme Doughnuts Inc.

Introduction and overview

Krispy kreme doughnuts inc. and its brief history

Krispy Kreme Doughnuts, Inc. is a producer of yeast-raised doughnuts. It is famous for the Original Glazed, the sweet and amazingly fluffy doughnut variety. The company’s shops also offer snack food, fruit pies, cinnamon buns, and beverages, including coffee, espresso, and frozen drinks. Its headquarters is located at Winston-Salem, North Carolina. Krispy Kreme can be found in 41 US States, as well as in Australia, Canada, Hong Kong, Indonesia, Japan, Kuwait, Mexico, Philippines, Republic of South Korea, Qatar, Saudi Arabia, United Arab Emirates and United Kingdom, with approximately 460 stores worldwide as of April 9, 2008. Its principal subsidiaries are Krispy Kreme Doughnut Corporation; Krispy Kreme Distributing Company, Inc.; Krispy Kreme Coffee Company, LLC; Krispy Kreme Mobile Store Company; HD Capital Corporation; HDN Development Corporation; Montana Mills Bread Co., Inc.; Panhandle Doughnuts, LLC; Oliver Acquisition Corp.; Krispy Kreme International Ltd. (Switzerland); Hot Doughnuts Now International Ltd. (Switzerland); Krispy Kreme Europe Limited (U.K.).

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In 1933, Vernon Carver Rudolph, the founder of Krispy Kreme, and his uncle purchased from a French chef from New Orleans a doughnut shop, along with it, the secret yeast-raised doughnut recipe. In 1935, Rudolph moved the operations to Nashville, Tennessee. In 1937, Rudolph establishes Krispy Kreme Doughnuts in Winston-Salem, North Carolina, focusing on retail operations to meet public demands, after initially focusing on wholesaling. By the late 1950’s, the company has established 29 shops in 12 states.

Krispy Kreme Doughnut Corporation became a wholly-owned subsidiary of Beatrice Foods Company of Chicago in 1976. But in 1982, Krispy Kreme became an independent company again when it was purchased from Beatrice Foods by a group of investors headed by Joseph McAlee, Sr. In 1995, Krispy Kreme opened its first shop outside the South in Indianapolis. The first New York City Krispy Kreme outlet makes its debut in 1996. In 1999, the First West Coast store opens in La Habra, California.

Krispy Kreme made its initial public offering in 2000, with 141 stores in 27 states. This move raised $63 million of net proceeds in NASDAQ. In 2001, Krispy Kreme opened its first store outside the United States; as well as moved its stock to the New York Stock Exchange. It acquired Montana Mills Bread Co., Inc. for $40 million in stock in 2003. The company has been rapidly expanding its international operations since 2004. Read about Doughnut Industry

Industry overview

In 2002, the doughnut industry —a $3.6 billion category— was the fastest-growing dining category, with a 9% sales growth, twice the industry average; the three fastest-growing doughnut chains are Dunkin' Donuts, Krispy Kreme and Tim Horton’s (USA Today, 2003).

Krispy Kreme’s principal competitors are Allied Domecq Quick Service Restaurants (owner of the Dunkin Donuts franchise); Starbucks Corporation; Winchell's Donut Houses Operating Company, L.P.; The TDL Group, Ltd. (operator of Tim Horton’s); and Cinnabon (Referenceforbusiness.com, 2008).

Krispy Kreme is among the top players in this industry, with the company achieving a 38.7% sales growth in 2002, compared to the 8.1% and 20% figures of Dunkin Donuts and Tim Horton’s, respectively; the company also earned a sales figure of $622 million, compared with $2.7 billion and $115 million of Dunkin and Horton’s (USA Today, 2003).

Krispy Kreme’s position in the industry is a factor for its success. Being a famous brand makes it easier for the company to expand its operations within the country, as well as in the international scene. Read about open access good example

Major concerns and issues

Doughnuts, being an unhealthy food, face a threat as consumers look for healthier alternatives. In 2005, “Krispy Kreme has announced that it has lowered its fiscal 2005 earnings guidance as a result of lower sales that may be impacted by individuals on the low carb diet its plans to close or sell its Montana Mills restaurants” (AIB International, 2008). A shift in consumer preferences towards healthier alternatives spells lower earnings, and could lead a reduction in the company’s operations.

Potential ethical situation

Krispy Kreme might face yet again an issue of ethical bankruptcy like it did in 2005, when it likely missed a Dec. 15 filing deadline after failing to report earnings for the last four quarters, as they have been embroiled in a controversy over how they accounted for the repurchase of franchises owned by former Krispy Kreme executives. A tighter and more open reporting should defray ethical questions about this company.

Journal entries

Krispy Kreme and activity-based costing

Activity-based costing is a practice in which activities are identified and all related costs of performing them are calculated, providing actual costs chargeable. This method estimates the costs of resources consumed by cost objects such as products and customers. Krispy Kreme uses the activity-based system, enabling the company to market their product efficiently allowing this company to lead their competition within the market. Since the goal of ABC is “to understand overhead and the profitability of products and customers” (Garrison, 2000), the information provided by this system helps Krispy Kreme in determining which are its profitable products, and which are not. Knowing this, they can build an effective marketing strategy to promote its less than lucrative products, at the same time maintaining the popularity of its other products.

Krispy kreme and ethical issues

Krispy Kreme’s credibility had already been questioned, especially in 2004; “contributing factors for that change are Krispy Kreme's recent posting of a 55-percent drop in second-quarter earnings, an ongoing Securities and Exchange Commission investigation into the company's franchise-buyback accounting and a stock price that recently was 64 percent lower than at the same time last year”(AEG Partners, 2004). The sudden declaration of Krispy Kreme of the drop in its earnings and blaming it on the popularity of low carb diets has been deemed questionable. The same can be said of its accounting treatment of its franchise-buybacks, of not amortizing. Ethical questions in this and several organizations have resulted from the Enron accounting scandal. A tighter and more open accounting reporting has been implemented to defray any ethical question of this company.

Krispy Kreme and budgeting

Three main areas that must be accounted in the budget process are production, franchising and distribution. Production should be necessarily included, Krispy Kreme being a manufacturing company. This budget would be used as basis by the company in estimating its production related costs, and in evaluating the pricing of such products. A production budget is a detailed plan showing the number of units that must be produced during a period in order to meet both sales and inventory needs. Franchising budget should also be included, since a substantial portion of Krispy Kreme’s income comes from this. Distribution budgets must also be taken into consideration given the wide market of the company. How Krispy Kreme will make its products available to its consumers is a very necessary aspect of its operations. These three areas cover the basis of the company and by using activity based budgeting in each of the three areas, all costs can be accounted for.

Activities that should also be considered are financing, investing and future growth. By including these activities, actual operating costs can be captured which will enable Krispy Kreme to make full use of money saving techniques in financing the operation, investing and managing assets to aid in profit margin and up hold responsibility to shareholders and finally, to maintain brand name recognition by expanding into global markets

Krispy Kreme’s cost drivers

Cost driver is any factor which causes a change in the cost of an activity. It is a factor, which causes overhead costs. Normal cost drivers of Krispy Kreme may include direct-labor hours, machine hours, units produced and units sold.  Some of cost drivers for allocating a company’s service department costs include hours of service or volume handled by materials handling, square footage occupied for custodial services, labor-hours or clients or patients serviced for cost accounting, kilowatt hours used or capacity of machines for power and number of employees, employees turnover or training hours for human resources.

Besides the normal cost drivers, operating drivers factor for a large amount of the cost used by Krispy Kreme. The company produces doughnuts for the company owned retail stores; it makes doughnut mixes and other ingredients to sell to their franchise operations, which is another operating cost driver to include the management and support to franchisees.

These are considered as cost drivers since the cost of operating Krispy Kreme production along with franchise obligations require the company hire more employees and incurred such cost of which will be passed to consumers; these are factors which affects the cost of the activity.

Krispy Kreme’s indirect costs

An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. Indirect costs absorbed by Krispy Kreme in the last few years include benefit packages for upper management costing the company large amounts of monies and/ or liability with little or no return to Krispy Kreme’s financial standing, as well as salaries of its upper management. These are considered indirect costs since these cannot be traced to a particular cost object. Even without production, these costs will be incurred by the company.

Flexible budget for Krispy Kreme

 A flexible budget provides estimates of what costs should be for any level of activity within a specified range. “When a flexible budget is used in performance evaluation, actual costs are compared to what the costs should have been for the actual activity during the period rather than to the budgeted costs from the original budget” (Garrison, 2000). Krispy Kreme must employ flexible budgets for better control and supervision since it anticipates the costs for different levels of activities. It allows management to readily compare cost information even when the expectation differs from what actually happened.

Increased sales’ Impact on pricing strategy

An increased sales or revenue indicate the profitability of the products. The sustained rapid growth of the company also shows the immense market potential of Krispy Kreme. With increased sales, Krispy Kreme might want to evaluate its pricing policies, and further examine if they could increase the price without losing favor with its customers. Or it could maintain its previous prices and find a way to minimize its costs so as to arrive at the maximum earnings possible. Increased sales also boost Krispy Kreme’s market potential. This means that the company can pursue its goal of corporate expansion, since there is untapped market out there. A good market potential is a positive sign for success.

Conclusion

Krispy Kreme has been incorporated in 1937. It has come a long way since then. From the doughnut shop in Winston-Salem, North Carolina, it now has more than 460 stores in over 41 US states, as well as in Asia and Australia. The use of activity based costing helps management in better assessing the profitability of its products and services, by more clearly determining its cost. The budgets to be prepared as part of its operating budget, should include areas of production, franchising and distribution, since these comprise vital activities of Krispy Kreme. Activity based costing should be used so that all costs can be accounted for. Krispy Kreme’s cost drivers include the normal ones, such as units produced and units sold, as well as operating cost drivers.

Activity-based costing and budgeting helps an organization in their planning, control, supervision and forecasting. These are cost analysis tools which provide information necessary for the company to formulate its strategy.

Recommendation

Krispy Kreme has been in the spotlight lately with issues of its management’s credibility. Issues of sugarcoating its financial statements to please Wall Street have been buzzing aplenty. Even with large revenues, and huge growth, a company will not be successful if it loses the trust and confidence of its stockholders, as well as of the general public. The doubtful practices of Krispy Kreme, such as delaying in declaring lower revenues and blaming it on the proliferation of low-carb diets, and its accounting for franchise buybacks should be avoided. A more conservative approach should be employed. Krispy Kreme must not be as aggressive in declaring its targeted revenues. In accounting for the franchise buy-backs, the company must amortize. Their practice of not amortizing is not against the letter of GAAP, but it is against the spirit thereof.

 Also, some critics believe that the aggressive expansion undertaken by Krispy Kreme is to blame for the troubles it now faces. The problem with this strategy is that it is extremely difficult to sustain this kind of growth. Most of the time, new stores are not able to sustain the same level of sales it had during its opening month. It takes additional work to maintain that level of revenues. Krispy Kreme’s strategy should be adjusted. They should not aim to open up as much new stores, but instead focus some of its efforts in monitoring its current stores to make sure that they are in good condition.

Considerations

Being in the food business, Krispy Kreme cannot help but be affected by the changes in the consumers’ preferences. Lately, people have been seeking healthier alternatives to the high calorie, fat enriched traditional doughnuts. Krispy Kreme should be more responsive to this shift and maximize this opportunity. The company has already taken a step in this direction by offering lower calorie products, such as whole wheat doughnuts, and light glazed doughnuts. However, they could do so much more. They can develop more products in this category.

References

1. Garrison, R.H., & Noreen, E.W. (2000). Managerial Accounting. USA: The McGraw-Hill Companies, Inc.
2. AEG Partners. Analysts: Krispy Kreme outlook not so sweet: company admits operational and strategic changes needed to increase profits. Retrieved April 22, 2008, from https:// www.aegpartners.com/news/index.htm
3. AIB International. Doughnut Statistics and Trends. Retrieved April 21, 2008, from https://www.aibonline.org/resources/statistics/doughnut.html
4. Krispy Kreme Doughnuts, Inc. Investor Relations. Retrieved April 20, 2008, from http://www.krispykreme.com/investorrelations.html
5. Krispy Kreme Doughnuts, Inc. Krispy Kreme History. Retrieved April 20, 2008, from http://www.krispykreme.com/funfacts.html
6. Referenceforbusiness.com. Krispy Kreme Doughnuts, Inc. - Company Profile, Information, Business Description, History, Background Information on Krispy Kreme Doughnuts, Inc.. Retrieved April 20, 2008, from http://www.referenceforbusiness.com/history2/ 68/Krispy-Kreme-Doughnuts-Inc.html
7. USA Today. Jumpin' jelly! Doughnuts dominate dining growth. Retrieved April 20, 2008, from http://www.usatoday.com/money/industries/food/2003-05-27-doughnut-growth_x.htm.

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