For commissary operations, GAAP accounting can help in effective inventory management, cost tracking, and financial analysis. However, it is often loosely adhered to in practice. Below, we have summarized some best practices to assist with your cost accounting and reporting, allowing your restaurant to have better data for informed decision-making and operations accountability.
Basics of cost accounting – components
Accounting for commissary operations involves direct material cost, as well as allocated labor and overhead costs, to determine the full cost of inventory usage. Commissary operations should consider the following inventory management components to assist with cost accounting:
- Purchases: Recording all purchases of goods and supplies.
- Inventory costing methods: Inventory management methods such as FIFO or LIFO. In practice for commissary operations, we’ve observed that many use the FIFO method for simplicity and due to quick inventory turnover.
- Inventory reserves: Establishing loss estimates for inventory management, including expired and unsellable product.
Calculating a standard labor rate
In addition to purchased component cost, commissaries should establish a standard labor rate to allocate personnel costs incurred to products produced and available to sell. To calculate a standard labor rate, the commissary needs to track the following employee costs to allocate by labor hours worked:
- Gross wages/salaries, including any bonuses and incentives paid to commissary employees
- Some commissaries will include overtime in their standard labor rate cost calculation. If overtime is a normal component of your operations, we advise including overtime pay in your calculation. However, if overtime is rarely utilized, it should not be captured in a labor rate and instead recognized as a period expense as incurred.
- Employer payroll taxes
- Employer-sponsored benefits, including health insurance, paid time off, and other insurance coverages.
The most common allocation method for labor rates is to sum the above labor costs and divide by regular labor hours (note, if capturing overtime pay, then would need to include overtime hours) to calculate a per labor hour cost. Generally, a commissary will utilize the prior year’s actual costs and hours worked as a starting base and adjust as needed for anticipated changes in cost (e.g., increase to pay rate per hour for the current year) and/or labor hours. The per labor hour cost is then capitalized to inventory based on labor hours.
Calculating the overhead burden rate
The most commonly missed costs in cost accounting are the overhead costs that support commissary operations. These costs include indirect labor (e.g., supervisors’ wages), utilities, rent, depreciation, maintenance and repair, janitorial, supplies, and training costs as typical examples. Marketing, advertising and selling expenses, as well as general and administrative expenses attributable to business activities as a whole, are not eligible to capitalize and instead are expensed as recognized.
Similar to calculating a standard labor rate, commissaries will generally utilize the prior year’s actual costs incurred and adjust as needed for the current year’s budget to determine the total costs to be allocated. Once costs are accumulated, an allocation base must be determined. Many commissaries use the direct labor hours approach for simplicity and create two cost rates allocated by the same input (direct labor and overhead burden both allocated by direct labor hour). Other commissaries may elect machine hours or square footage as allocation bases. As long as the allocation base is consistently applied, it is permissible under GAAP rules.
Commonly missed items
In working with commissaries on their cost accounting, we’ve found the following costs to be commonly missed in calculating the fully absorbed costs of production:
- Indirect labor costs as part of overhead (e.g., supervisor salaries)
- Employee benefits, such as PTO
- Training costs
- Depreciation and other non-cash expenses, such as amortization
- Maintenance and repair costs of machines used in production
We suggest as commissaries complete budget to actual financial analysis, as well as review of current operating results and spending, that a regular analysis be completed to evaluate whether costs are related to inventory production and captured in the allocation rates.
As your commissary establishes its direct labor and overhead allocation rates, it’s important to complete regular review and variance analysis to identify any changes in cost, efficiency, and production. These rates should be updated at a minimum annually and may be updated as often as quarterly to ensure reporting accuracy. Utilizing standard rates will also invariably lead to variances compared to actual production, although it is an expected part of cost accounting. To the extent variances are excessive, this may indicate that the current allocation rates need to be revised to align with production activities.
By establishing and reviewing direct labor and overhead rates, your commissary will better identify all-in production costs for financial analysis and strategic decision-making. Contact your GBQ advisor for help implementing these best practices.
