Managerial Accounting Term Paper

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Dick and Mac McDonald opened their first restaurant in 1940 in San Bernadino, California. These men were among the first to introduce the concept of "fast food," and made dining fun for children. McDonald's went on to enjoy over 60 years of growth, which has only tapered in the last year due to a failure to expand successfully into places such as Bolivia. Despite these recent setbacks, it is notable that only the third world could thwart McDonald's is a testament to its brand name and its revenue model. There are currently over 28 thousand McDonald's Restaurants in over 120 countries. McDonald's global sales in 2000 were over 40 billion, and the company could boast 16 billion customers that year.

McDonald's success didn't occur in an incremental, measured fashion. The company only really took off in 1954 when a mixer salesman, Ray Kroc, discovered the operation and found a way to serialize the business format introduced in the original McDonalds. Although the issuance of licenses to sell products had been introduced by the Singer Sewing Machine Company over a hundred years prior to Ray Kroc's utilization of the model, it can be argued that his implementation of this formula was the most successful. As a franchise, however, McDonalds needed to employ much stricter accounting standards in order to convince potential franchisees to do business with the company. In this assignment I will review the differences between the accounting standards used prior to Kroc's involvement with those implemented after he partnered with the McDonalds brothers.

II. McDonald's Accounting Standards

A. 1940-1954, The Early Years

The franchising information available on the McDonald's web site notes "We franchise only to individuals, not to corporations, partnerships, or passive investors." Although these individuals are required to maintain strict records of their finances, these are mandated by the franchising agreement rather than GAAP. As a company that was wholly owned by two individuals, the accounting standards of the original McDonald's were limited to what would be pursuant to a normal partnership.

The original McDonalds drive-in hot dog stand was built just east of Pasadena, California with borrowed lumber, and was entirely self-financed. The McDonalds brothers, Dick and Mac, had arrived from New Hampshire and previously run a movie theater in Glendale, California that was rarely able to do more than break-even. Three years later they moved to a peculiarly octagon-shaped building at Fourteenth and E. Street in San Bernadino, California, then a sleepy working class exurb of Los Angeles. The brothers did not maintain books until after 1948, although their operation was by no means one that could be managed by these men alone; by 1948 they had come to employ 20 carhops.

Although as a general partnership they would have not been required to file as a taxable entity, both Dick and Mack would have been required to file their personal income statements noting the existence of the partnership and any income generated. A partnership is seen as a conduit for personal income similar to an individual proprietorship; the procedure governing these partnerships is to be found in subchapter K of the IRS code. General partners are required to fill out form 1065; those that live in California are additionally required to fill out state tax form 565.

The bellhops working for Dick and Mac MacDonald would have been required to fill out the all-too-familiar 1040 form after 1942. Although a withholding tax was introduced in the late 1930's, it only pertained to certain companies. The fist withholding tax to come into general use was implemented during the 2nd World War in 1942 and was referred to as the Victory Tax. For many Americans, this was the first experience that they had filing an income tax. Although the income tax had been introduced in 1913, it pertained exclusively to the wealthiest Americans. Four million Americans were income tax payers in 1939; by 1945 that number had risen to 43 million out of a total population of approximately 140 million people. Although the 1942 tax was initially only approved for two years, Congress enjoyed its new source of wartime revenue and faced the prospect of maintaining a permanent military presence in Germany and the North Atlantic. This tax has remained with us ever since.

A constant stream of revenue throughout the 1940's de-emphasized the need for Dick and Mac to implement formal bookkeeping procedures. This oversight proved costly.

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It was only in 1948, when the brothers were considering opening a diner, that they analyzed receipts that they'd kept for the last three years and discovered that the sale of hamburgers had accounted for a full 80% of sales volume. This didn't justify the thousands of dollars that the two had dedicated to maintaining their barbecue pit, which they had advertised heavily in flyers and over the radio. Nonetheless, the brothers were regularly pulling in 200 thousand dollars in revenue annually and were splitting 25 thousand dollars in profit.

Twenty five thousand dollars a year was a lot of money in the late forties, enough to buy the brothers a 25-room mansion. Perhaps more importantly, twenty-five thousand dollars was the cut-off for the high income tax bracket. During the Great Depression, President Roosevelt had implemented a 90% tax on all individual income earned in excess of twenty-five thousand dollars a year in the Wealth Tax Act of 1935. A subsequent wartime increase placed taxes on income above 25 thousand a year at 96%. Roosevelt, who had confiscated all privately owned American gold bullion and dined with Stalin at Yalta in the Crimean region of the Ukraine where the latter's "progressive" communist mandates had caused millions to starve, is thought by many to have harbored socialist sympathies: during the war he issued a decree that no one could make more than $25,000 after taxes. This was prudently overridden by congress.

Although these rates were eased during the Truman administration, it fell to the Kennedy administration to realize that if individuals had no incentive to earn their money, they'd do something else with their time, a policy that was expanded by the Reagan administration. Throughout the late 40's and early 50's, however, the MacDonald's partnership faced individual taxes of 70% should they report an individual income in excess of 25 thousand dollars. That the brothers took home 25 thousand each reflected the structural mandates of the existing tax code.

This re-investment came in 1948 due to the analysis of receipts that lead the brothers to completely re-vamp their operation. That fall, all of the carhops (who were thought to be slowing down business) were fired and McDonalds was re-invented as a counter operation where customers had to wait at a counter in order to receive their food. Not only did the smaller staff (employees still ran the counter) result in lower overhead, the brothers were able to streamline their operation by reducing the number of items on the menu from twenty-five to nine.

The McDonalds brothers decided to focus on their core proficiency: the production of hamburgers. In this they were a cost-leader, keeping the cost low so as to maximize volume. The pre-cooking weight of these hamburgers was reduced from 1/8 pound to 1/10 pound. The hamburger's cost was slashed from thirty cents to a mere fifteen cents. In simplifying their product, the McDonalds brothers were able to track volume and predict costs more effectively. Their menu was later increased by the addition of two items: French fries and milkshakes. Within six months, volume reached pre-conversion levels. Their product attracted working families with young children who were previously put off by the drive-thru's reputation as a hangout for teenagers. McDonalds made restaurant eating affordable to working people for the first time, which had previously taken most of their meals at home. This demographic continues to define the appeal of McDonalds in regions of the globe where restaurant eating is still a privilege only afforded the relatively wealthy.

Despite their initial success, the McDonald's brothers lacked the financial know-how to approach venture investors with their revenue model. Careful attention to the maintenance of financial records would not only have provided them with a viable pitch to provide investment bankers (who were not at that time a common fixture in the distant suburbs of Los Angeles) but would have allowed them to develop a more viable method for the development of the first franchise the brothers tried to sell: the Speedee Service System. For $1,000, the brothers would provide building plans, loan their counter-man Art Bender for a week, and provide franchisees with a basic description of their Speedee Service. Accountability was not encouraged; the thousand dollars was a one-time fee - the Speedee Service was a turnkey operation. It was left to Ray Kroc to re-invent the company in a way that.....

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