Case Analysis

Christine Martin had just been appointed vice$-$president of the Great Lakes Region of the Bank Services Corporation $($BSC$).$ The company provides cheque$-$processing services to small banks. The banks send cheques presented for deposit or payment to BSC$,$ which records the data on each cheque in a computerized database. BSC then sends the data electronically to a Canadian Payments Association cheque$-$clearing centre where the appropriate transfers of funds are made between banks. The Great Lakes Region has three cheque$-$processing centres, which are located in Burlington, Kingston, and Owen Sound, Ontario. Prior to her promotion to vice$-$president, Christine had been the manager of a cheque$-$processing centre in Nova Scotia.

Immediately upon assuming her new position, Christine requested a complete financial report for the just$-$ended fiscal year from the region$$s controller, Farnando Romer. Christine specified that the financial report should follow the standardized format required by corporate headquarters for all regional performance reports. That report shows in Appendix $1.$

Upon seeing this report, Christine summoned Farnando Romer for an explanation.

Christine: What$$s the story on Owen Sound? It didn$$t have a loss the previous year, did it$?$

Farnando: No$,$ the Owen Sound facility has had a nice profit every year since it opened six years ago, but Owen Sound lost a big contract this year.

Christine: Why?

Farnando: One of our national competitors entered the local market and bid very aggressively on the contract. We couldn$$t afford to meet the bid. Owen Sound$$s costs$$particularly their facility expenses$$are just too high. When Owen Sound lost the contract, we had to lay a lot of employees off, but we could not reduce the fixed costs of the Owen Sound facility.

Christine: Why is Owen Sound$$s facility expense so high? It$$s a smaller facility than either Kingston or Burlington, yet its facility expense is higher.

Farnando: The problem is that we are able to rent suitable facilities very cheaply in Kingston and Burlington. No such facilities were available at Owen Sound; 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.

Christine: Well, we can$$t do that any more. The Owen Sound facility will obviously have to be shut down. Its business can be shifted to the other two cheque$-$processing centres in the region.

Farnando: I would advise against that. The $$1,200,000$ in depreciation at the Owen Sound facility is misleading. That facility should last indefinitely with proper maintenance. And, it has no resale value; there is no other appropriate commercial activity around Owen Sound.

Christine: What about the other costs at Owen Sound?

Farnando: If we shifted Owen Sound$$s business over to the other two processing centres in the region, we wouldn$$t save anything on direct labour or variable overhead costs. We might save $$90,000$ or so in local administrative expense, but we would not save any regional administrative expense, and corporate headquarters would still charge us $9\mathrm{.}5\%$ of our sales as corporate administrative expense. In addition, we would have to rent more space in Kingston and Burlington in order to handle the work transferred from Owen Sound; that would probably cost us at least $$600,000$ a year. And don$$t forget that it will cost us something to move the equipment from Owen Sound to Kingston and Burlington. And the move will disrupt service to customers.

Christine: I understand all that, but a money$-$losing processing centre on my performance report is completely unacceptable.

Farnando: But if you shut down Owen Sound, you are going to throw some loyal employees out of work.

Christine: That$$s unfortunate, but we have to face hard business realities.

Farnando: And you would have to write off the investment in the facilities at Owen Sound.

Christine: I can explain a write$-$off to corporate headquarters. Hiring an inexperienced contractor to build the Owen Sound 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 centres. Owen Sound has to go$.$ At the next corporate board meeting, I am going to recommend that the facility be closed.

Required:

Write a report from the standpoint of the company as a whole, whether the Owen Sound processing centre should be shut down and its work redistributed to other processing centres in the region. Include your discussion what the impact of depreciation would have on the price charged by Owen Sound.

Appendix $1$

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