Question
Barings Telephone Company In April 2015, Mark Rowe, president of Barings Telephone Company, a public utility company, was preparing for a meeting with Susan Bradley,
Barings Telephone Company
In April 2015, Mark Rowe, president of Barings Telephone Company, a public utility company,
was preparing for a meeting with Susan Bradley, manager of Barings Data Services, a company
subsidiary. Partial deregulation and an agreement with the government had permitted Barings
Telephone to establish a computer data service subsidiary to perform data processing for the
telephone company and to sell computer service to other companies and organizations. Mr.
Rowe had told the government in 2012 that a profitable computer services subsidiary would
reduce pressure for telephone rate increases. However, by the end of 2014 the subsidiary had
yet to experience a profitable month. Ms. Bradley felt only more time was needed, but Rowe
felt action was necessary to reduce the drain on company resources.
Barings Data Services had grown out of the needs of Barings Telephone for computer services
to plan, control, and account for its own operations in the region it served. The realization by
Barings that other businesses in the region needed similar services and that centralized service
could be provided over telephone circuits suggested that Barings could sell computer time not
needed by telephone operations. In addition, the government had encouraged all public
utilities under its jurisdiction to seek new sources of revenue and profits as a step toward
deregulation and to reduce the need for rate increases which higher costs would otherwise
bring.
Because it operated as a public utility, the rates charged by Barings Telephone Company for
telephone service could not be changed without the approval of the government. In presenting
the proposal for the new subsidiary, Mr. Rowe had argued for a separate but wholly owned
entity whose prices for service would not be regulated. In this way, Barings could compete with
other computer service organizations in a dynamic field; in addition, revenues for use of
telephone services might also be increased. The government accepted this proposal subject
only to the restriction that the average monthly charge for service by the subsidiary to the
parent not exceed $82,000, the estimated cost of equivalent services used by Barings
Telephone Company in 2012. All accounts of Barings Data Services were separated from those
of Barings Telephone, and each paid the other for services received from the other.
From the start of operations of Barings Data Services in 2013 there had been problems.
Equipment deliveries were delayed. Personnel had commanded higher salaries than expected.
And most important, customers were harder to find than earlier estimates had led the company
to expect. By the end of 2014, when income of Barings Telephone was low enough to
necessitate a report to shareholders revealing the lowest return on investment in seven years,
Rowe felt it was time to reassess Barings Data Services. Susan Bradley had asked for more time,
as she felt the subsidiary would be profitable by March. But when the quarterly reports came
(Tables 1 and 2), Rowe called Bradley to arrange their meeting.
Rowe received two reports on operations of Barings Data Services. The Summary of Computer
Utilization (Table 1) summarized the use of available hours of computer time. Service was
offered to commercial customers 24 hours a day on weekdays and eight hours on Saturdays.
Routine maintenance of the computers was provided by an outside contractor who took the
computer off-line for eight hours each week for testing and upkeep. The reports for the quarter
revealed a persistent problem; available hours, which did not provide revenue, remained high.
Revenue and cost data were summarized in the quarterly report on results of operations (Table
2). Intracompany work was billed at $400 per hour, a rate based on usage estimates for 2015
and the government's restrictions that cost to Barings Telephone should not exceed an average
of $82,000 per month. Commercial sales were billed at $800 per hour.
While most expenses summarized in the report were self-explanatory, Rowe reminded himself
of the characteristics of a few. Space costs were all paid to Barings Telephone. Barings Data
Services rented the ground floor of a central exchange building owned by the company for
$8,000 per month. In addition, a charge for custodial service based on the estimated annual
cost per square foot was paid by Data Services, as Telephone personnel provided these
services.
Computer equipment had been acquired by lease and by purchases; leases had four years to
run and were nto cancelable. Owned equipment was all salable but probably could not bring
more than its book value in the used equipment market.
Wages and salaries were separated in the report to show the expense of four different kinds of
activities. Operating salaries included those of the six persons necessary to run the center
around the clock as well as amounts paid hourly help who were required when the computer
was in operation. Salaries of the programming staff who provided service to clients and
maintained the operating system were reported as system development and maintenance.
Sales personnel, who called upon and serviced present and prospective commercial clients,
were also salaried.
Because of its relationship with Barings Telephone, Barings Data Services was able to avoid
many costs an independent company would have. For example, all payroll, billing, collections,
and accounting were done by telephone company personnel. For those corporate services,
Barings Data Services paid Barings Telephone an amount based on wages and salaries each
month.
Although Rowe was discouraged by results to date, he was reluctant to suggest to Bradley that
Barings Data Services be closed down or sold. The idea behind the subsidiary just seemed too
good to give up easily.
Besides, he was not sure that the accounting report really revealed the contribution that Data
Services was making to Barings Telephone. In other cases, he felt that the procedures used in
accounting for separate activities in the company tended to obscure the costs and benefits they
provided.
After examining the reports briefly, Rowe resolved to study them in preparation for asking
Bradley to estimate the possible effects on profits of increasing the price to customers other
than Barings Telephone, reducing prices, increasing sales efforts and promotion, and of going to
two-shift rather than 24-hour operations.
Questions
1. Appraise the results of operations of Barings Data Services. Is the subsidiary really a problem
to Barings Telephone Company? Consider carefully the differences between reported costs and
costs relevant for decisions that Mark Rowe is considering.
2. Assuming the company demand for service will average 205 hours per month, what level of
commercial sales of computer use would be necessary to break even each month?
3. Estimate the effect on income of each of the options Rowe has suggested if Bradley
estimates as follows:
a. Increasing the price to commercial customers to $1,000 per hour would reduce
demand by 30 percent.
b. Reducing the price to commercial customers to $600 per hour would increase demand
by 30 percent.
c. Increased promotion would increase sales by up to 30 percent. Bradley is unsure how
much promotion this would take. (How much could be spent and still leave Barings Data
Services with no reported loss each month if commercial hours were increased 30
percent?)
d. Reducing operations to 16 hours on weekdays and eight hours on Saturdays would
result in a loss of 20 percent of commercial revenue hours.
4.Can you suggest changes in the accounting and reporting system now used for operations of
Barings Data Services which would result in more useful information for Rowe and Bradley?
Table
1
Barings Data Services Summary of Computer Utilisation First Quarter 2015
Revenue Hours January February March
Intercompany 206 181 223
Commercial 127 135 138
Total revenue hours 333 316 361
Service Hours 32 32 40
Available hours 175 188 167
Total hours 540 536 568
Revenues:
Intercompany sales $82,400 $72,400 $89,200
Commercial sales:
Computer use 98,400 108,000 110,400
Other 9,241 9,184 12,685
Total revenue $190,041 $189,584 $212,285
Expenses
Space costs
Rent $8,000 $8,000 $8,000
Custodial services 1,240 1,240 1,240
9,240 9,240 9,240
Equipment costs:
Computer leases 95,000 95,000 95,000
Maintenance 5,400 5,400 5,400
Depreciation:
Computer equipment 25,500 25,500 25,500
Office equipment and
fixtures 680 680 680
Power 1,633 1,592 1,803
128,213 128,172 128,383
Wages and salaries:
Operations 29,496 29,184 30,264
Systems development and
maintenance 12,000 12,000 12,000
Administration 9,000 9,000 9,000
Sales 11,200 11,200 11,200
61,696 61,384 62,464
Materials 9,031 8,731 10,317
Sales promotions 7,909 7,039 8,083
Corporate services 15,424 15,359 15,236
Total expenses $231,513 $229,925 $233,723
Net income (loss) -$41,472 -$40,341 -$21,438
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