Breezy Company

(This case was prepared by Elizabeth Morris, Lehigh University)

Breezy Company of Bethlehem, Pennsylvania, is a small wholesale distributor of heating and cooling fans. The company deals with retailing firms that buy small to medium quantities of fans. The president, Chuck Breezy, was very pleased with the marked increase in sales over the past couple of years. Recently, however, the accountant informed Chuck that although net income has increased, the percentage of uncollectibles has tripled.

Because of the small size of the business, Chuck fears he may not be able to sustain these increased losses in the future. He asked his accountant to analyze the situation.

Background

In 1998, the sales manager, John Breezy, moved to Alaska, and Chuck hired a young college graduate to fill the position.

The company had always been a family business and, therefore, measurements of individual performance had never been a large consideration. The sales levels had been relatively constant because John had been content to sell to certain customers with whom he had been dealing for years. Chuck was leery about hiring outside the family for this position. To try to keep sales levels up, he established a reward incentive based on net sales. The new sales manager, Bob Sellmore, was eager to set his career in motion and decided he would attempt to increase the sales levels.

He recruited new customers while keeping the old clientele. After one year, Bob had proved himself to Chuck, who decided to introduce an advertising program to further increase sales. This brought in orders from a number of new customers, many of whom Breezy had never done business with before. The influx of orders excited Chuck so much that he instructed Jane Breezy, the finance manager, to raise the initial credit level for new customers.

This induced some customers to purchase more.

Existing System

The accountant prepared a comparative income statement to show changes in revenues and expenses over the last three years, shown in Exhibit A. Currently, Bob is receiving a commission of 2 percent of net sales.

Breezy Company uses credit terms of net 30 days. At the end of previous years, bad debt expense amounted to approximately 2 percent of net sales.

As the finance manager, Jane performs credit checks. In previous years, Jane had been familiar with most clients and approved credit on the basis of past behavior. When dealing with new customers, Jane usually approved a low credit amount and increased it after the customer exhibited reliability. With the large increase in sales, Chuck thought that the current policy was restricting a further rise in sales levels. He decided to increase credit limits to eliminate this restriction. This policy, combined with the new advertising program, should attract many new customers.

Future

The new level of sales impresses Chuck and he wishes to expand, but he also wants to keep uncollectibles to a minimum. He believes the amount of uncollectibles should remain relatively constant as a percentage of sales. Chuck is thinking of expanding his production line, but wants to see uncollectibles drop and sales stabilize before he proceeds with this plan.

Required. Analyze the weaknesses in internal control and suggest improvements.

EXHIBIT A BREEZY COMPANY COMPARATIVE INCOME STATEMENT FOR YEARS 2005, 2006, 2007 2005 2006 2007 Revenues: Net sales $ 350,000 $ 500,000 $ 600,000 Other revenue 60,000 60,000 62,000 Total revenue 410,000 560,000 662,000 Expenses: Cost of goods sold 140,000 200,000 240,000 Bad debt expense 7,000 20,000 36,000 Salaries expense 200,000 210,000 225,000 Selling expense 5,000 15,000 20,000 Advertising expense 0 0 10,000 Other expenses 20,000 30,000 35,000 Total expenses 372,000 475,000 566,000 Net income $ 38,000 $ 85,000 $ 96.000