Introduction to the company

PepsiCo is a leading global beverage, snack and Food Company. They manufacture or

use contract manufacturers, market and sell a variety of salty, convenient, sweet and

grain-based snacks, carbonated and non-carbonated beverages and foods in

approximately 200 countries, with its largest operations in North America (United States

and Canada), Mexico and the United Kingdom. PepsiCo’s commitment to sustainable

growth, defined as Performance with Purpose, is focused on generating healthy financial

returns while giving back to the communities it serves. This includes meeting consumer

needs for a spectrum of convenient foods and beverages, reducing its impact on the

environment through water, energy and packaging initiatives, and supporting its

employees through a diverse and inclusive culture that recruits and retains world-class

talent.

The Pepsi Cola Company began in 1898 by a Pharmacist and Industrialist Caleb

Bradham, but it only became known as PepsiCo when it merged with Frito Lay in 1965.

Until 1997, it also owned KFC, Pizza Hut, and Taco Bell, but these fast-food restaurants

were spun off into Tricon Global Restaurants. In December 2005, PepsiCo surpassed

Coca-Cola Company in market value for the first time in 112 years since both companies

began to compete.

PepsiCo’s Operations

PepsiCo is organized into three business units, as follows:

(1) PepsiCo Americas Foods (PAF), which includes Frito-Lay North America (FLNA),

Quaker Foods North America (QFNA) and all of Latin American food and snack

businesses (LAF)

(2) PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages North

America and the entire Latin American beverage Businesses; and

(3) PepsiCo International (PI), which includes all PepsiCo businesses in the United

Kingdom, Europe, Asia, Middle East and Africa

These three business units are comprised of six reportable segments (referred to as

divisions), as follows:

- Frito-Lay North America (FLNA)

- Quaker Foods North America (QFNA)

- Latin America Foods (LAF)

- PepsiCo America Beverages (PAB)

- United Kingdom & Europe (UKEU), and

- Middle East, Africa & Asia (MEAA).

The part of our concern in this report will be the Middle East, Africa and Asia (MEAA)

division as our research and collected data is confined to this region.

Middle East, Africa & Asia

MEAA manufactures, markets and sells through consolidated businesses as well as

through non controlled affiliates, a number of leading salty and sweet snack brands

including Lay’s, Doritos, Cheetos, Smith’s and Ruffles. Further, MEAA manufactures or

Uses contract manufacturers, markets and sells many Quaker brand cereals and snacks.

MEAA also manufactures markets and sells beverage concentrates, fountain syrups and

finished goods, under various beverage brands including Pepsi, Marinda, 7UP and

Mountain Dew. These brands are sold to authorized bottlers, independent distributors and

retailers. However, in certain markets, MEAA operates its own bottling plants and

distribution facilities. In addition, MEAA licenses the Aquafina water brand to certain of

It’s authorized bottlers. MEAA also manufactures or uses contract manufacturers,

markets and sells ready-to-drink tea products through an international joint venture with

Unilever.

Com petition

PepsiCo operates in highly competitive markets. It competes against global, regional,

local and private label manufacturers on the basis of price, quality, product variety and

distribution. In U.S. measured channels, its chief beverage competitor, The

Coca-Cola Company, has a larger share of carbonated soft drinks (CSD) consumption,

while PepsiCo has a larger share of liquid refreshment beverages consumption. In

addition, The Coca-Cola Company has a significant CSD share advantage in many

markets outside the United States. Further, PepsiCo’s snack brands hold significant

leadership positions in the snack industry worldwide. Its snack brands face local and

regional competitors, as well as national and global snack competitors, and compete on

the basis of price, quality, product variety and distribution. Success in this competitive

environment is dependent on effective promotion of existing products and the

introduction of new products. PepsiCo believes that the strength of its brands, innovation

and marketing, coupled with the quality of its products and flexibility of its distribution

network, allow it to compete effectively.

Critical Accounting Policies

These policies may require management to make difficult and subjective judgments

regarding uncertainties, and as a result, such estimates may significantly impact

Company’s financial results. The precision of these estimates and the likelihood of future

changes depend on a number of underlying variables and a range of possible outcomes.

PepsiCo’s critical accounting policies arise in conjunction with the Following:

• Revenue recognition,

• Brand and goodwill valuations,

• Income tax expense and accruals

Revenue Recognition

PepsiCo’s products are sold for cash or on credit terms. The credit terms, which are

established in accordance with local and industry practices, typically require payment

within 30 to 90 days internationally, and may allow discounts for early payment. It

recognizes revenue upon shipment or delivery to its customers based on written sales

terms that do not allow for a right of return. However, its policy for DSD and chilled

products is to remove and replace damaged and out-of-date products from store shelves

to ensure that consumers receive the product quality and freshness they expect. Similarly,

its policy for certain warehouse-distributed products is to replace damaged and out-of-

date products. Based on the company’s experience with this practice, it has reserved for

anticipated damaged and out-of-date products.

Brand and Goodwill Valuations

PepsiCo sells products under a number of brand names, many of which were developed

by PepsiCo. The brand development costs are expensed as incurred. There are other

brands that PepsiCo has acquired. Upon acquisition, the purchase price is first allocated

to identifiable assets and liabilities, including brands, based on estimated fair value, with

any remaining purchase price recorded as goodwill. Determining fair value requires

significant estimates and assumptions based on an evaluation of a number of factors, such

as

marketplace participants

product life cycles

market share

consumer awareness

brand history and future expansion expectations

amount and timing of future cash flows

the discount rate applied to the cash flows.

The company believes that a brand has an indefinite life if it has a history of strong

revenue and cash flow performance, and we have the intent and ability to support the

brand with marketplace spending for the foreseeable future. If these perpetual brand

criteria are not met, brands are amortized over their expected useful lives, Which

generally range from five to 40 years.

Income Tax Expense and Accruals

The annual tax rate is based on company’s income, statutory tax rates and tax planning

opportunities available in the various jurisdictions in which the company operates.

Significant judgment is required in determining annual tax rate and in evaluating tax

position. Deferred tax liabilities generally represent tax expense recognized in financial

statements for which payment has been deferred, or expense for which the company

has already taken a deduction in tax return but have not yet recognized as expense in the

financial statements. In 2008, the annual tax rate was 26.8% compared to 25.9% in

2007.The tax rate in 2008 increased 0.9 percentage points primarily due to the absence of

the tax benefits recognized in the prior year related to the favorable resolution of certain

foreign tax matters, partially offset by lower taxes on foreign results in the current year.

In 2009, annual tax rate is expected to be approximately the same as 2008.

Financial performance

Snacks volume grew 10%, reflecting broad-based increases. Beverage volume grew 11%,

Acquisitions had a nominal impact on beverage volume growth. CSDs grew at a high-

single-digit rate and noncarbonated beverages grew at a double-digit rate. Net revenue

grew 22%, reflecting volume growth and favorable effective net pricing. Operating profit

grew 25%, driven by the net revenue growth, partially offset by increased commodity

costs.

Hierarchal structure of the company

Following are the board of directors of PepsiCo International

Victor J. Dzau,

Arthur C. Martinez,

Sharon Percy Rockefeller,

Daniel Vasella,

Alberto Ibargüen,

Lloyd G. Trotter,

Dina Dublon,

Michael D. White,

Ray L. Hunt,

Indra K. Nooyi,

Ian M. Cook,

James J. Schiro

Further; following is the hierarchal structure that PepsiCo. International operates in

Lays- Potato Chips

Lay's is the brand name for a number of potato chip (a.k.a

crisps) varieties as well as the name of the company that founded

the chip brand in 1938. Lay's chips are marketed as a division of

Frito-Lay, a company owned by PepsiCo Inc. since 1965

For the internal accounting analysis purposes we have selected

the snacks department of PepsiCo. In this department we further narrow it down to

“Lays”

In Pakistan, Lays is available in mainly 5 flavors and is now the most popular snack

amongst youngsters of the country.

French Cheese

Salted

Masala

Tango

Bar B.Q

Factory Tour:

Our group paid a visit to the office of PepsiCo located in Gulberg, Lahore. We needed to

have a one-on-one conversation with the staff to get an idea of how PepsiCo handles its

internal finances. Since this kind of information was not available officially, we decided

to get it first hand.

Since we had set a meeting beforehand, we did not face any difficulty in getting in. The

staff, on a general level, was very friendly and helpful. Although, they did make us wait

for about half an hour before beginning the interview.

We were escorted to a room upstairs which was finely decorated, just like the entrance

lounge. The Factory Finance Manager from the snacks department introduced himself

and the question answer session begun.

He briefed us about the cost of goods sold which included direct material, direct labor

and manufacturing overhead costs. He then elaborated each category with the specific

example of potato chips. The raw material includes potatoes, oil and flavor. The direct

labor comprised of three steps

1. Raw Material

2. Processing

3. Packaging

Lastly, he explained the manufacturing overhead with the example of electricity. Other

than this, he told us about the marketing costs that were incurred by the company. Its

record is kept separately.

In the beginning, they were quite reluctant about giving out the information. However,

they cooperated with us on the maximum level which they thought was appropriate.

Internal Accounting Procedures

The snacks department of Pepsi Co. has the following major divisions where costs are

accumulated.

Production

Finance

Cost Classification

Manufacturing Costs Non- Manufacturing Costs

Direct Labor

Manufacturing Overhead

Selling Costs

Administrative Costs

FixedManufacturing

Overhead

Variable Manufacturing

Overhead

R&D

Planning

Personnel

Marketing

SAD(sales and distribution)

ANM (advertising and marketing)

GNA (General and administrative)

The costing is mainly associated to the production department. The rest of this report

includes a detailed analysis of the costing procedures carried out in PepsiCo’s snack’s

production department.

Costs Classification:

Direct Material

Manufacturing Costs:

Manufacturing cost is the expenditure incurred in carrying out the production processes

of an organization. The manufacturing cost includes direct costs, for example, labor,

materials, and expenses, and indirect costs, for example, subcontracting and overheads.

The costs identified as manufacturing costs in the production of Lays are as follows

1. Direct Materials

The materials that go into final product are called raw materials

Potato

Oil

Seasoning(flavour)

Film (packet)

Carton

2. Direct Labour

The term direct labor is reserved for those labor costs that can be essentially traced to

individual units of products. Direct labor is sometime called touch labor, since direct

labor workers typically touch the product while it is being made. Direct labour includes

worker working in

Input Department

Peeling department

Washing department

Slicing department

Frying department

Seasoning department

Packaging Department

3. Manufacturing Overheads

Manufacturing overhead, the third element of manufacturing cost, includes all costs of

manufacturing except direct material and direct labor.

Variable manufacturing overheads includes

Electricity

Gas (gas generator)

Nitrogen (N2) flush

Utility expenses

Repairing costs

Maintenance costs

Fixed manufacturing overheads includes

Rental costs (if gas generator is hired on rent)

Transportation costs

Meals

Depreciation

Indirect labour includes

Labour used in service department

Security guards

Labour in engineering department

Warehousing labour

Labour in quality department

Overtime

Indirect material includes

Food stickers

Non-Manufacturing costs

Non manufacturing costs are those costs that are not incurred to manufacture a product.

Examples of such costs are salary of sales person and advertising expenses. Generally

non manufacturing costs are further classified into two categories.

1. Marketing and Selling Costs

2. Administrative Costs

1. Marketing & Selling Costs :

Marketing or selling costs include all costs necessary to secure customer orders and get

the finished product into the hands of the customers. These costs are often called order

getting or order filling costs. These costs include;

Commissions

Placement costs

Transportation costs (per unit of product is charged)

2. Administrative costs

Administrative costs include all executive, organizational, and clerical costs associated

with general management of an organization rather than with manufacturing, marketing,

or selling. Examples of administrative costs include executive compensation, general

accounting, secretarial, public relations, and similar costs involved in the overall, general

administration of the organization as a whole. For PepsiCo, Snacks department following

costs are identified as its administrative costs;

Salaries

Office expenditure including furniture and stationery costs

Depreciation costs (offices)

Cost classification on the basis of cost behaviour

Apart from classifying costs as manufacturing and non-manufacturing costs, costs are

also classified on the basis of their behaviour. These are the

Variable costs

Fixed costs

1. Variable Costs

Variable cost is a cost that varies, in total, in direct proportion to changes in the level of

activity. In case of the manufacturing of Lays a number of variable costs are incurred.

The first is electricity cost. The electricity is generated from gas generators so the gas will

also be considered as a variable cost. 

2. Fixed costs

Fixed Cost is a cost that remains constant, in total, regardless of changes in the level of

activity within the relevant range. In case of the manufacturing of Lays the fixed costs

incurred are firstly the depreciation of the fixed assets being used. Second is the cost of

the permanent staff. The transportation cost i.e. cost of transporting potatoes from the

farm to plant and then from the plant to warehouse is also considered as a fixed cost. The

rental cost e.g. of the generators that are used to generate electricity is also fixed cost.

Other Costs:

Other costs include the fringe benefits and the extra benefits given to the employees.

Fringe benefits are perks offered to employees in order to keep them motivated and for

the purpose of retaining them.

Fringe benefits given to labor include

Meal

Transportation

Overtime

Extra benefits to higher executives includes (varies with status)

Pay roll

Provident fund

Medical free facility

Transport

Fuel expense

Cell phones (monthly bill of cell paid)

Lays and Process Costing:

The snacks department of PepsiCo undertakes the process costing system because;

Identical units of products are being produced for a longer period of time on

continuous basis

Costs are accumulated by departments

Unit costs are computed by departments

Lays- Departments:

Production department three main departments that are involved in the manufacturing of

lays potato chips. These include

Input department

Processing department

Packaging department (taping department)

Input Department:

Grade A Potatoes are brought from farms owned by PepsiCo. Before putting them into

process they are first checked for quality inspection. And once approved they are put for

further processing.

Processing department:

This department is further subdivided into 5 sub-departments;

Washing

Peeling

Slicing

Frying

Seasoning

First the potatoes are thoroughly washed in water. Next the skin is gently peeled off so

that the flavor remains.  After which potatoes are thinly sliced and rinsed again to remove

any excess starch. Then the slices are cooked to a crispy crunch in all natural-oil. Lays

Classic Potato chips were cooked in hydrogenated oil until 2007. Currently, the chips are

made with 100% pure sunflower oil which is lower in saturated oil. Finally the chips are

topped with a sprinkle of salt or other seasonings.

Packaging:

The processed potatoes are packed into their respective packets. And before sealing the

packets Nitrogen flush is passed through the packets in order to maintain the life span of

the product to three to four months. Then these packets are sealed and packed into the

cartons. And finally these finished product inventory is sent to ware houses or purchase

points.

The Cost Flow System

The Direct materials, direct labor and manufacturing over head costs are transferred to

work in process account and from their it is then transferred to the finished goods

inventory.

The cost flow is further illustrated by the following sequence of diagrams.

1. to record the use of direct material

2. To record the direct labor costs

3. To apply manufacturing overhead to departments

General assumptions undertaken by the company

Labor is the fixed cost

Discretionary fixed costs include

- R&D expenses

- Quality maintenance expenses

- Advertising expenses

Committed fixed costs include

- Labor

- Contractual costs incurred as a result of contracts between distributors

Break Even

The planning manager of PepsiCo’s snacks department claims that break even is a

requirement for companies that are not properly established and for new businesses. As

PepsiCo is a strong brand and an established business, it does not require breakeven

analysis to run their business instead they use break even analysis at lower level to

analyze the profit margins. He claims that their existence in the market is as the result of

PepsiCo’s objective of profit maximization and target profiting and not just meeting the

expenses

Appendix A is the Cost of Goods sold and contribution margin statement which could be

used for break even analysis.

Break even can be calculated using the formula

Break even in rupees = Fixed expenses

CM Ratio

Dollar sales to attain Target profit = Fixed expense + Target profit

CM Ratio

Costing Procedures

Both variable and absorption costing procedures are used. In PepsiCo they mainly focus

on variable costing approach which they use for decision making while the absorption

costing is used for analyzing the financial figures.

This again brings us to Appendix A

Budgets

Introduction

A budget is a plan expressed in dollar amounts that acts as a road map to carry out an

organization’s objectives, strategies and assumptions.

A company might have a master budget or profit plan for the upcoming year. The master

budget will include a projected income statement and balance sheet. Within the master

budget will be operating budgets such as a sales budget, production budget, marketing

budget, administrative budget, and budgets for departments. In addition there will be a

cash budget and a capital expenditures budget.

It is a common practice that the budgets prepared for the next accounting year will be

detailed by quarter or by month. It is also typical that the annual budget will not be

changed once the actual year begins. For managers, a budget is a guide that it not so rigid

that it prevents timely action when needed. In rare circumstances the annual budget might

be revised, but only when the business environment has radically changed.

Operating budget approach

The company uses the operating budget approach in which the budget is made for the

whole year i.e. 12 months from January to December which is reviewed almost every

month but it is not the rolling one to check if there are some variances there are

afterwards corrected according to the current situation.

Participative budgeting approach

The company also uses self imposed budgeting or participative budgeting approach in

which they ask all the managers from different departments to give their requirements

and allocate costs to their requirements then these requirements are overviewed by

administration for budgeting.

For instance, plant manager are consulted for all the overheads because later it becomes

very difficult to knock down the whole process.

Budgeting committee

Budgeting committee is divided into

Control committee

Planning committee