The management of Longo Company, which has a June 30 fiscal year and sells merchandise at its home office and six branches, is considering closing Santee Branch because of its declining sales volume and excessive operating expenses. Longo’s contract with Lewis Hanson, manager of Santee Branch, provides that Hanson is to receive a termination bonus of 15% of the branch’s net income in its final period of operations, but no bonus in the event of a net loss in the final period. The contract is silent as to the measurement of the branch’s net income or loss.

For the period July 1 through October 31, 2005, the date Santee Branch ceased operations, its income statement prepared in the customary fashion by the branch accountant reported a net loss of $10,000. Hanson pointed out to Longo management that the loss was net of $30,000 advertising expenses that had been apportioned to the branch by Longo’s home office in September 2005, prior to Longo management’s decision to close the branch on October 31. Hanson alleged that it was inappropriate for the branch to absorb advertising costs for a period in which it would no longer be making sales presumably initiated in part by the advertising. The controller of Longo responded that under the same line of reasoning, the branch’s October 31, 2005, inventories, which included a $60,000 markup over home office cost, should be reduced by that amount, with a corresponding increase in the branch’s net loss, because the home office would never realize the markup through future sales by Santee Branch.
Instructions Do you agree with the Santee Branch manager, with the controller of Longo Company, with both, or with neither? Explain.