Evaluate the results of operations of Prestige Data Services (Exhibits 1 and 2). Is the subsidiary really a problem to Prestige Telephone Company? Briefly analyze the cost behavior of the revenues and expenses for Prestige Data.
The results of operations of Prestige Data Services were achieved by utilizing the Exhibit 2, which provides a summary of the company's operations in the course of the first quarter of 1997. According to the exhibit, it is eminent that both the fixed costs and variable costs are detailed in the report. Despite that, based on the customary accounting rules, the specific costs that should be considered during decision making are the variable costs. Additionally, the opportunity cost associated with the computer equipment leases that had four years left was also non-concealable. The company was obliged to act with the aim of deregulation, which would subsequently reduce the urge for a rate increase.
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Moreover, provided that the company would want to shut down Data services (PDS), it would be mandatory to source and pay an outside company to deliver the services to the Prestige Telephone Company (PTC) with loss of the revenue attributed to commercial sales. Concerning space currently utilized by the Prestige Data services, the company ought to rent out space to a different company. Prestige Telephone Company would have the advantage of laying off some employees since no salaries and wages would be paid.
It is a clear indication that the loss decreased from the month of January to March and can be determined through exhibit 2. It is forecasted that the loss will ultimately turn into profits for the company in the months ahead. In this case, the concrete thing is the short term outlook given for the financial results from January to March. It is inappropriate to draw exclusive conclusions from the short term outlook. Examples of the exclusive conclusions include retention and the shutdown situation that prove to be serious decisions that cannot lay based on the short-term estimates. It is paramount to conclude that the retention of Prestige Data Service has greater significance as compared to a complete shutdown because of the future possibility of the company thriving and making more profits.
Assume a variable cost of $28 per hour, commercial revenues of $800 per hour, and fixed costs of $115,820. Also, assume actual utilization of 138 hours – this is what is given in Exhibit 1 for March. (Please ignore any intercompany effects for this question). What is the break-even volume (hours)?
The formula for break-even is given by;
Fixed costs / (Revenue per unit-Variable costs per unit)
Fixed cost = $115,820
Revenue per unit = $800
Variable cost per unit = $28
$115,820 / (800 – 28) = 150 hours
Estimate the effect on income of each of the options Rowe has suggested if Bradley estimates as follows:
Increasing the price to commercial customers to $1,000 per hours would reduce demand by 30%.
Demand was for 138 hours in March 1997; thus, a 30% reduction would leave demand of 96.6 hrs (138 Hrs. * 0.70 = 96.6 Hrs).
Demand * contribution per hour = 96.6Hrs * ($1000 - $28) = $93895
In comparison with the current 138 Hrs * ($800 - $28) = $106536, the monthly contribution to fixed costs as well as income at $800 is greater by an amount of $12641 than the contribution anticipated at $1000. It means, therefore, that the income will be more given the $800/hour price. Thus the proposed change would decrease income.
Reducing the price to commercial customers to $600 per hour would increase demand by 30%.
Demand was for 138 hours in March 1997; hence a 30% rise would result in demand of 179.4 hours (138hours * 1.30 = 179.4 hours)
179.4 hours * ($600 - $28) = $102617
In comparison to the current contribution of $106,467, a reduction in price would evidently decrease profit by a margin of $3850, which is a decrease of 4% on the cost margin monthly.
Reducing operations to 16 hours on weekdays and eight hours on Saturdays would result in a loss of 20% of commercial revenue hours.
This would result in a reduction in demand for commercial revenue hours by 20%;
0.2 * 138 = 110.4 hours. The new contribution margin will be;
110.4 hours x ($800 - $28) = $85,229 which is a reduction of $21,307. The proposed changes will affect the fixed cost as follows;
| Current (24 hrs) | Proposed (16hrs) | |
| operations | 21600 | 14,904 |
| System development and maintenance | 12600 | 12000 |
| administration | 9000 | 9000 |
| sales | 11200 | 11200 |
| materials | 10317 | 10317 |
| Sales promotions | 8083 | 8083 |
| Corporate service | 15236 | 15236 |
| TOTAL FIXED COST | 223,436 | 216740 |
Savings $6,696 in terms of fixed expenses at the expense of losing a contribution of $21,307 is not the best decision.
If increased promotion would increase sales by 30%, how much can be spent each month without reducing income?
Increase in demand revenue hours from 138 to 179.4 (1.3 * 138)
Total expected commercial = 179.4 * (800 – 28) = $138,497
The difference between the new contribution margin and the current contribution margin of $106,467, which is $32,030, could be spent without reducing income.
What specific suggestions for improving the accounting system and report format would you suggest to Rowe and Bradley so that they might more easily understand how well Prestige Data is performing?
In line with improving the accounting system and the report format to better understand how well Prestige Data is performing, I would prefer that it opts to use consolidated financial statements. The consolidated financial statements would cover both the parent and subsidiaries since the statements would play a significant role in determining the actual contribution that Prestige Data Service provides to the Prestige Telephone Company. Certain costs within Prestige data prove beneficial to the parent company, but in the context are only perceived as expenses as far as the Prestige Data Services are concerned. However, the costs do not indicate the beneficial aspect of these services in the provision of revenue for the Prestige Telephone Company. It is, therefore, advisable for Prestige Data Services to factor in the variable costs as opposed to focusing only on reported costs when making decisions.
Additionally, to understand how well Prestige Data is performing, Cost-Volume-Profit analysis should be adopted because it helps make projections in the operating level that minimizes operating losses. CVP plays a significant role in ensuring that the company succeeds as far as its targeted operating income is concerned. One vital factor to consider is the break-even point of the company. Understanding the company's break-even point helps target higher sales volumes above the known break-even point to foster profitability. From the case study, it can be concluded that the total profit of Prestige Data Services relies on the commercial hours sold and the price of commercial sales.
By utilizing contribution analysis, the Prestige Data Service's profitability will be guaranteed eventually by rising commercial hours, which will then reduce losses. Given the profitability, it would then be prudent to retain Prestige Data Services as a subsidiary to the Prestige Telephone Company. Rowe and Bradley need to consider increasing advertising because it a rational as well as a practical approach. It would be important to understand that the amount in promotion expense should be increased such that it does not exceed $31 960.8. Meanwhile, the minimization of inefficiencies is vital so that the hourly overhead can be reduced.
