“Revenue hours” represent the key activity that drives costs at Salem Data Services. Which expenses in Exhibit 2 are variable with respect to revenue hours? Which expenses are fixed with respect to revenue hours?
Response
Variable expenses refer to costs that change directly and proportionally to the changes in the amount of revenue hours. Such costs increase with the increase in the number of revenue hours in Salem Data Services. Such variable expenses include power costs and salaries of hourly personnel. The powers costs increase with increase in the amount of revenue hours in Salem Data Services. Similarly, the salaries of hourly personnel increase with the increase in the amount of revenue hours. If the revenue hours have to be increased, the hourly personnel have to work for more hours hence increasing the amount of salary paid to them.
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Fixed expenses refer to indirect costs that are not dependent on the amount of revenue hours produced by Salem Data Services. The fixed expenses tend to be time related and a company has to incur whether production takes place or not. Fixed expenses are often referred to as overhead costs. The fixed costs in Salem Data Services include rent, custodial services, computer leases, maintenance costs, computer depreciation costs, office equipment and fixtures depreciation costs, salaried staff expenses, system development and maintenance expenses, administration costs, sales costs, sales promotion expenses, and corporate services. Fixed costs are normally used in breakeven analysis to determine pricing as well as the level of production and sales under which a company generates neither profit nor loss.
For each expense that is variable with respect to revenue hours, calculate the cost per revenue hour.
Response:
The cost per revenue hour is calculated by dividing the variable in a particular month by the revenue hours.
The electricity cost per revenue hours is calculated as follows:
The values of the respective variable costs and revenue hours of the month of March will be used.
March revenue hours = 361
March power cost = $1697
Therefore, the power cost per revenue hour is
$1697/361 = $4.7 per revenue hour
The cost of hourly personnel per revenue hour is also calculated by dividing the cost of hourly personnel by the total revenue hours as follows:
March revenue hours = 361
March hourly personnel cost = $8664
Therefore, the hourly personnel cost per revenue hours is
$8664/361 = $24 per revenue hour
Create a contribution margin income statement for Salem Data Services. Assume that intra-company usage is 205 hours. Assume commercial usage is at the March level.
Contribution margin income statement for Salem Data Services for March 2014
| January | February | March | |
| Revenues ($) | |||
| Sales | |||
| Intra-company | $82000 (205*400) | $82000 (205*400) | $82000 (205*400) |
| Commercial | $110400 (138*800) | $110400 (138*800) | $110400 (138*800) |
| $192400 | $192400 | $192400 | |
| Variable costs ($) | |||
| Power | 1546 | 1486 | 1697 |
| Hourly personnel | 7896 | 7584 | 8664 |
| $9442 | $9070 | $10361 | |
| Contribution Margin | $182952 | $183330 | $182039 |
The contribution margin statement shows all the variable expenses deducted from sales to arrive at a contribution margin. The contribution margin statement is very essential in planning and decision making.
Assuming the intra-company demand for service will average 205 hours per month, what level of commercial revenue hours of computer use would be necessary to break even each month?
The total fixed costs of Salem Data Services are:
Rent 8000
Custodial services 1240
Computer leases 95000
Maintenance costs 5400
Computer depreciation costs 25500
Office equipment and fixtures
depreciation costs 680
Salaried staff expenses 21600
System development and
maintenance expenses 12000
Administration costs 9000
Sales costs 11200
Sales promotion expenses 7909
Corporate services 15424
Total $212,953
The amount of fixed costs covered by the intracompany sales (205*400) = 82000
The remaining fixed costs that should be covered by commercial sales (212953-
82000) = 130953
The amount of commercial revenue hours required to break even will be:
$130953/$800 = 164 commercial revenue hours
Estimate the effect on income of each of the options Flores has suggested if Wu estimates as follows:
• Increasing the price to commercial customers to $1,000 per hour would reduce demand by 30%.
Response:
Current income = 138*800 = $110400
Reducing demand by 30% = 138*0.7 =97
Resultant income = 97*1000 = 97000
Variance = 110400-97000 = $13400
Increasing the price to commercial customers to $1000 will reduce income by $13400
• Reducing the price to commercial customers to $600 per hour would increase demand by 30%.
Current income is $110400 (138*800)
Increasing demand by 30% = 138*1.3 = 179 revenue hours
Resultant income = 179*600 = $107400
• Increased promotion would increase revenue hours by up to 30%. Wu is unsure how much promotion this would take. (How much could be spent and still leave Salem Data Services with no reported loss each month if commercial hours were increased 30%?)
Response
Promotion cannot be directly traced to the increase in commercial hours. Increasing promotion may increase the amount of commercial hours but it is hard to estimate how much promotion can result to a 30% increase in commercial hours.
Based on your analysis above, is Salem Data Services really a problem to Salem Telephone Company? What should Flores do about Salem Data Services?
Response:
Based on my analysis of Salem Data Services, it appears that it is a problem to Salem Telephone Company. This is because Salem Data Services has a lot of hours available for revenue that remain unutilized. Salem Data Services has approximately 38% of unutilized hours that are available for revenue. Moreover, Salem Data Services has a huge proportion of fixed costs that impact on the profitability of the company. The commercial sales have not increased significantly over the three months indicating that the long term potential of the investment is not promising. Therefore, Salem Telephone Company should sell Salem Data Services and consider outsourcing the services in order to eliminate the huge overheads occasioned by the subsidiary.
