A Problem in Decision-Making.

The Middle-Atlantic Territory of the Flick Company has produced results for the past three years which average as follows:

Sales Cost of goods sold-standard Gross profit Operating expenses:

Commissions—10% gross profit Salaries Stationery Supplies Postage

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$ 1,380,000 975,000

$ 405,000 4,365 14,400 15,700 7,200 18,300 60,000 427,120

$__(22,120)

Sales promotion and home office expenses are allocated to territories on the basis of sales revenues. Credit and collection expenses are allocated on the basis of customers, whereas warehousing costs are allocated on the basis of orders, and delivery costs are allocated on the basis of miles traveled.

The company recognizes some arbitrariness in its cost allocations to sales territories but feels that the allocations are necessary to portray adequately the income of each territory.

To support bases of allocation, the company has found the following correlations to exist.

Sales promotion expenses —

Home office expenses Credit and collection expenses Warehousing expenses Delivery expenses a variable rate of .2 percent of sales a variable rate of 1 percent of sales a variable rate of $1.50 per customer per year a variable rate of $1.80 per order a variable rate of $0.09 per mile traveled During the past three years, the number of customers has averaged 500, number of orders has averaged 2,000, and miles traveled by delivery trucks in the territory has averaged 150,000. Payroll taxes usually average 3 percent total commissions and salaries.
The average sales breakdown is as follows:
Products x 4 Z Units soldin cor rscci- 80,000 60,000 100,000 Units selling price.... §$ 4.50 $ 4.50 $ 7.50 Lotal.Saless, 4 & 3.5 + $ 360,000 $ 270,000 $ 750,000 Unit standard manufacturing costs for each product are as follows:
Products Xx is Z Variable Costs ...... $ 1.50 $ 0.60 $ 3.60 PIKeOCOSIS 25.t cc, ty. 22) $ 3.15 $_.90 Total Unit Cost ... 313 3.75 4.50 In terms of controls, the territory manager cannot influence the fixed portions of allocated costs, insurance, general taxes, and his own salary of $24,000.
Management is quite concerned about the profitability of this territory. They have tried every conceivable means of reducing costs to no avail. Now they are considering the following alternatives to improve income:

a. Abandon the territory.

b. Attempt to improve territory profit by a change in product mix via a heavier concentration on Product Y which contributes as much to fixed costs and profits as Product Z.

c. Operate as they are currently operating.
Complete abandonment of the territory would not result in a reduction of fixed manufacturing costs or the fixed costs of the home office or service departments. All other costs would be eliminated.
The heavier concentration on Product Y would not change the sales picture for Products X and Z nor the sales price of Product Y. A sales promotion program which will cost $30,000 annually is expected to increase unit sales of Product Y by 20,000. The extra production of Product Y will require overtime and thus a 10 percent increase in variable manufacturing costs and a $3,000 annual increase in fixed manufacturing costs. New customers should average 20, new orders would average 50, and miles traveled should remain stable.
Required:

a. If you were the accountant for the Flick Company, what would your calculations force you to recommend to management?

b. By how much would fixed costs of manufacturing, the home office, and service departments have to change for you to consider revising your recommendations?
What other income-improvement alternatives do you see in this type of situation?
ao How might capital employed in the territory enter into your recommendations?