CASE 13-30 Ethics and the Manager; Shut Down or Continue Operations LO13-2 00 Haley Romeros had just been appointed vice president of the Rocky Mountain Region of the Bank Services Corporation (BSC). The company provides check processing services for small banks. The banks send checks presented for deposit or payment to BSC, which records the data on each check in a computerized database. BSC then sends the data electronically to the nearest Federal Reserve Bank check-clearing center where the appropriate transfers of funds are made between banks. The Rocky Mountain Region has three check processing centers, which are located in Billings, Montana; Great Falls, Montana; and Clayton, Idaho. Prior to her promotion to vice president, Ms. Romeros had been the manager of a check processing center in New Jersey. Immediately after assuming her new position, Ms. Romeros requested a complete financial report for the just-ended fiscal year from the region's controller, John Littlebear. Ms. Romeros specified that the financial report should follow the standardized format required by corporate headquarters for all regional performance reports. That report follows: Bank Services Corporation (BSC) Rocky Mountain Region Financial Performance Check Processing Centers Total Billings Great Falls Clayton Sales Operating expenses: Direct labor $50,000,000 $20,000,000 $ 18,000,000 $12,000,000 32,000,000 12,500,000 11,000,000 8,500,000 Variable overhead Equipment depreciation 850,000 3,900,000 350,000 1,300,000 310,000 1,400,000 1,200,000 190,000 Facility expense 2,800,000 900,000 800,000 1,100,000 Local administrative expense 450,000 140,000 160,000 150,000 Regional administrative expense 1,500,000 600,000 540,000 360,000 Corporate administrative expense 4,750,000 1,900,000 1,710,000 1,140,000 Total operating expense 15,920,000 12,640,000 Net operating income (loss) 46,250,000 17,690,000 $ 3,750,000 $ 2.310.000 $ 2,080.000 $ (640,000) seeing this report, Ms. Romeros summoned John Littlebear for an explanation. Page 618 F Upon seeing this report, Ms. Romeros summoned John Littlebear for an explanation. Romeros: Littlebear: Romeros: Littlebear: Romeros: Littlebear: Romeros: Littlebear: What's the story on Clayton? It didn't have a loss the previous year did it? No, the Clayton facility has had a nice profit every year since it opened six years ago, but Clayton lost a big contract this year. Why? One of our national competitors entered the local market and bid very aggressively on the contract. We couldn't afford to meet the bid. Clayton's costs-particularly their facility expenses-are just too high. When Clayton lost the contract, we had to lay off a lot of employees, but we could not reduce the fixed costs of the Clayton facility. Why is Clayton's facility expense so high? It's a smaller facility than either Billings or Great Falls and yet its facility expense is higher. The problem is that we are able to rent suitable facilities very cheaply at Billings and Great Falls. No such facilities were available at Clayton; we had them built. Unfortunately, there were big cost overruns. The contractor we hired was inexperienced at this kind of work and in fact went bankrupt before the project was completed. After hiring another contractor to finish the work, we were way over budget. The large depreciation charges on the facility didn't matter at first because we didn't have much competition at the time and could charge premium prices. Well we can't do that anymore. The Clayton facility will obviously have to be shut down. Its business can be shifted to the other two check processing centers in the region. I would advise against that. The $1,100,000 in facility depreciation at the Clayton location is misleading. That Page 618 Romeros: Littlebear: Romeros: Littlebear: Romeros: Littlebears Romeros: in facility depreciation at the Clayton location is misleading. That facility should last indefinitely with proper maintenance. And it has no resale value; there is no other commercial activity around Clayton. What about the other costs at Clayton? If we shifted Clayton's sales over to the other two processing centers in the region, we wouldn't save anything on direct labor or variable overhead costs. We might save $90,000 or so in local administrative expense, but we would not save any regional administrative expense and corporate headquarters would still charge us 9.5% of our sales as corporate administrative expense. In addition, we would have to rent more space in Billings and Great Falls in order to handle the work transferred from Clayton; that would probably cost us at least $600,000 a year. And don't forget that it will cost us something to move the equipment from Clayton to Billings and Great Falls. And the move will disrupt service to customers. I understand all of that, but a money-losing processing center on my performance report is completely unacceptable. And if you shut down Clayton, you are going to throw some loyal employees out of work. That's unfortunate, but we have to face hard business realities. And you would have to write off the investment in the facilities at Clayton. I can explain a write-off to corporate headquarters: hiring an inexperienced contractor to build the Clayton facility was my predecessor's mistake. But they'll have my head at headquarters if I show operating losses every year at one of my processing centers. Clayton has to go. At the next corporate board meeting. I am going to 4 Romeros: from Clayton; that would probably cost us at least $600,000 a year. And don't forget that it will cost us something to move the equipment from Clayton to Billings and Great Falls. And the move will disrupt service to customers. I understand all of that, but a money-losing processing center on my performance report is completely unacceptable. Littlebear: And if you shut down Clayton, you are going to throw some loyal employees out of work. Romeros: Littlebear: Romeros: That's unfortunate, but we have to face hard business realities. And you would have to write off the investment in the facilities at Clayton. I can explain a write-off to corporate headquarters; hiring an inexperienced contractor to build the Clayton facility was my predecessor's mistake. But they'll have my head at headquarters if I show operating losses every year at one of my processing centers. Clayton has to go. At the next corporate board meeting. I am going to recommend the Clayton facility be closed. Required: 1. From the standpoint of the company as a whole, what is the financial advantage (disadvantage) of closing the Clayton processing center and redistributing its work to other processing centers in the region? Explain. 2. Why might it be in Haley Romeros's self-interest to shut down the Clayton facility? Do you think Haley Romeros is conducting herself in an ethical fashion? Explain. 3. What influence should the depreciation on the facilities at Clayton have on prices charged by Clayton for its services