Managerial Accounting Case Study 1: Salem Telephone Company

Group 1

96122050
96122051
96122052
96122073
96122085
96122088
96122092

Through our study of Salem Telephone Company (STC), were going to answer that if Salem Data
Services (SDS) is really a profitable business to keep by using break-even point analysis. Before we
come out the final solution, lets discuss SDS accounting report step by step.
First, we have to divide the various costs incurred in SDS into two types: variable costs and fixed costs.
From Exhibit 2 we can see that only Power and Operations: hourly personnel are variable costs
that have relation to the total revenue hours. Other expenses listed in Exhibit 2 are all fixed costs (Q1).
Besides, we can calculate the unit variable costs per revenue hour as follows (Q2):

Power
Operations: hourly personnel
Total variable costs
Total revenue hours
Variable costs per revenue hour

January
1,546
7,896
9,442
329
28.70

February
1,485
7,584
9,069
316
28.70

March
1,697
8,664
10,361
361
28.70

Furthermore, by distinguish the variable costs and fixed costs, we can construct the contribution margin
income statement for SDS at March level, assuming 205 hours for intracompany usage (Q3):
Revenues
Intracompany
82,000
Commercial
110,400
Total Revenues
192,400
Variable expenses (power + hourly personnel) 9,844
Contribution margin
182,556
Fixed expenses
Rent
8,000
Custodial services
1,240
Computer leases
95,000
Maintenance
5,400
Depreciation
26,180
Salaried staff
21,600
System development
12,000
Administration
9,000
Sales
11,200
Sales promotion
8,083
Corporate services
15,236
Total fixed expenses
212,939
Net income
-30,383

Based on above assumptions, we can obtain the number of commercial revenue hours as follows:
(205 400 + x 800) 28.7 (205 + x) 212939 = 0
82000 + 800 x 5884 28.7 x 212939 = 0

x=

212939 82000 + 5884

= 177.39 178
800 28.7

Therefore, SDS needs to serve at least 178 commercial hours to break even (Q4).
(Q5) According to Flores suggestion, if commercial price is increased to $1000, the demand reduces
30%, then the effect on net income will be:
x = 138 (1 0.3) 97
(205 400 + 97 1000) 28.7 ( 205 + 97) 212939 = 42606

Managerial Accounting Case Study 1: Salem Telephone Company

Group 1

On the other hand, if the commercial price is reduced to $600, the demand increases 30%. The result of
net income will be:
x = 138 (1 + 0.3) 180
(205 400 + 180 600) 28.7 (205 + 180) 212939 = 33989

Another suggestion is to increase 30% commercial hours by increasing sales promotion. In such way,
the extra costs from promotion should not exceed:
x = 138 (1 + 0.3) 180
(205 400 + 180 800) 28.7 (205 + 180) 212939 = 2012

(Q6) Now we discuss the two approaches suggested by Flores:

1.
Use pricing strategy to increase commercial revenue hours

This method will not add extra costs. However, according to our estimation above, changing
price to either $1000 (97 hours) or $600 (180 hours) can not prevent a net loss.
2.
Increase sales promotion cost to win more business but the price unchanged

If SDS wants to increase 30% of commercial sales, the extra promotion costs can not be
exceed $2012. Considering the promotion cost $8083 on March, additional $2012 is roughly
24.9%. That is, SDS can only increase 25% promotion cost to achieve 30% of growth.
Based on our analysis, SDS has large fixed costs so that its not easy to profit. However, SDS still has
chances to profit but need great efforts, which well mention later.
If SDS does not exist, STC has to purchase 205 intracompany hours from other companies at market
price $800, which costs $164000. In the meantime, STC also saves some costs if SDS closed:
Fixed expenses
Rent
Maintenance
Power
Salaried staff
Hourly personnel
System development
Administration
Sales
Sales promotion
Total saved expenses
Outsourcing costs
Extra cost if close SDS

8,000
5,400
1,697
21,600
8,664
12,000
9,000
11,200
8,083
85,644
164,000
-78,356

STC can only save $85644 by closing SDS, but it needs to spend $164000 to purchase service from
outside. In other words, STC needs to pay extra $78356 if SDS does not exist. Therefore STC should
keep SDS business.
Since SDS is essential to keep, the first priority of SDS goal is to break even, at least. We recommend
Cynthia Wu to combine both Flores suggestions. That is, both increase the promotion budget and also
reduce price, which will make SDS become profitable more easily.