Case 26-1

Import Distributors, Inc.[*]

Import Distributors, Inc. (IDI), imported appliances and distributed them to retail appliance stores in the Rocky Mountain states. IDI carried three broad lines of merchandise: audio equipment (tuners, tape decks, CD players, etc.), television equipment (including videotape recorders), and kitchen appliances (refrigerators, freezers, and stoves that were more compact than U.S. models). Each line accounted for about one-third of total IDI sales revenues. Although each line was referred to by IDI managers as a department, until 1994 the company did not prepare departmental income statements.

In late 1993, departmental accounts were set up in anticipation of preparing quarterly income statements by department starting in 1994. In early April of 1994, the first such statements were distributed to the management group. Although in the first quarter of 1994 IDI had earned net income amounting to 4.3 percent of sales, the television department had shown a gross margin that was much too small to cover the departments operating expenses (see Exhibit 1).

The television departments poor showing prompted the companys accountant to suggest that perhaps the department should be discontinued. This is exactly why I proposed that we prepare departmental statements to see if each department is carrying its fair share of the load, the accountant explained. This suggestion led to much discussion among the management group, particularly concerning two issues: First, was the first quarter of the year representative enough of longer-term results to consider discontinuing the television department? And second, would discontinuing television equipment cause a drop in sales in the other two departments? One manager, however, stated that even if the quarter was typical and other sales wouldnt be hurt, Im still not convinced wed be better off dropping television line.

Question

What action should be taken with regard to the television department?

EXHIBIT 1	TELEVISION DEPARTMENT
	Income Statement
	For the First 3 Months of 1994
			Percent
	Net sales revenues	$1,612,403	100.0
	Costs of sales	1,422,473	88.2
	Gross margin	189,930	11.8
	Operating expenses:
	Personnel expenses (Note 1)	10,140
	Department manager's office	12,393
	Rent (Note 2)	50,107
	Inventory, taxes, and insurance	37,214
	Utilities (Note 3)	3,006
	Delivery costs (Note 4)	32,248
	Sales commissions (Note 5)	80,621
	Administrative costs (Note 6)	40,310
	Inventory financing charge (Note 7)	23,708
	Total operating expenses	289,307	18.0
	Income taxes (credit)	(34,957)	(2.2)
	Net income (loss)	(64,920)	(4.0)
1) These were warehouse personnel. Although merchandise in the warehouse was arranged by department, these personnel performed tasks for all three departments on any given day.
2) Allcoated to departments on the basis of square footage utilized. IDI hada 5-year noncancelable lease for the facilities
3) Allocated to departments on the basis of square footage utilized.
4) Allocated on the basis of sales dollars. A delivery from IDI to a retail store typically included merchandise from all three departments
5) Salespersons were paid on a straight commission basis; each one sold all three lines
6) Allcoated on the basis of sales dollars.
7) An accounting entry that was not limited solely to the cost of financing inventory, assessed om average inventory in order to motivate department managers not to carry excessive stocks. This charge tend to be about 3 times the company's actual out-of-pocket interest costs.