Paukovich Consulting: The Case of the Unhappy Sales Force' Introduction Richard Paukovich, the owner and CEO of Paukovich Consulting, was late arriving to the company's weekly project status review meeting. Lately, he had dreaded these mcetings because they nearly always became shouting matches between the sales representatives and the consultants. He was disappointed in the lack of trust between the two parts of his company, but was at a loss about how lo improve morale and increase productivi This week's meeting was no exception. As he entered the conference room, Carol Barnet, scnior sales rep, was complaining that her most recent paycheck was short by over S500 and that it was probably because the Ecoba job was over budget. Carol was the leading complainer among the sales reps. She regularly pointed out that her monthly commission check was less than the estimated ommission Another sales rep, David Morion, chimed in. "Yes, Carol's right. The consultants always spend too much time on writing reports. And then projects are delivered late and the eustomers complain." Greg Bilton, the consultant assigned to the Ecoba job, retorted It's not our fault You sales reps always promise more than wc can deliver and you never budget enough time for projects. Ifyou did a better job of sctting customer expectations, then we could meet them." Richard spokc up, reminding Carol that "the reason that you and the other sales reps are paid from actual margins rather than forecast margins is to prevent you from expanding the scope of projects after they are sold and sneaking in extra work to the customers for free." After the meeting, CGreg grumbled privately to one of his consulting colleagues that c would be able to complete jobs on time if we knew which jobs would be coming in and if Richard didn't always pull us off other jobs to work on his projects." Paukovich Consulting Richard Paukovich had formed Paukovich Consuling 10 years earlier. The company provided customer satisfaction survey consulting services. Richard had developed a wide nctwork of client contacts, and he generated approximarely one third of the company's revenues. The remaining revenucs were generated by sales representatives The company was profitable for the owner, as shown in Exhibit 1 This case is based on a real company, but thc nac aud consulting niche have been changed to maintain confidentiality Exhibit: Prior Incomc Statements 20x2 20x1 Revenues $2,500,000 $2,000,000 Expenses President's salary Consultant salaries Sales representative commissions Other general and administrative salaries......... 50,000 290,000 180,000 135,000 Payroll taxes and employee benelits....252,000 150.000 270,000 200,000 130,000 231,000 Survey labor, printing, photocopying, and other direcr job costs Rent, heat, and lights Miscellaneous office costs 900,000 51,000 700,000 50,000 45.0 Total expenses Pretax incoime 771,000 229,000 497,000 Income tax expense @ 20% Net income 397,600 183,200 Project Pricing and Sales Commissions All sales reps werc responsible for writing their own proposals, although they could ask thc consultants for technical assistance as needed. The salcs reps were responsible for calculating the estimated cost and for setting the price for projects. After a turned each project over to a consultant to do the actual work. proposal was accepted, the sales reps The sales reps usually set the price at 320% of the estinored direct consulting labor cost plus 125% of the other direct costs (such as survey labor and photocopying). The estimated direct consulting labor cost was calculated by multiplying the estimated consulting hours by a standard labor ratc. A standard rate of S25 per hour was used for senior consultants, and a $20 ratc was used for junior consultants. The sales force was paid on straight sales commission. The commission was equal to 24% of the difference berween the price paid for a project by the client and the actual total direct costs of the project. After a project was complete, the actual labor hours were totaled and the actual direct consullant labor cost was calculated by multiplying actual hours times the labor rate. Other dircct costs were also accumulated for thejob. Then the sales rep's commission was calculated and paid. Exhibit 2 provides estimared cost, price, and commission information for a potential new jot 2 Exhibit 2: Potential New Job One of the sales rcpresentatives developed the following information for a potential new consuling erigagemcnt. Estimated consultant cost Scnior consultant Junior consultant 10 hours a $25 per hour 20 hours &$20 per hour 250 400 Total 650 Estimated other direct job costs Survey labor (outsourced) Photocopying of final report (outsourced) $1,000 Total S1050 Estimated price: Consultant cost Other direct costs $650 x 320% $ 1 ,050 x 1 25% $2,080 1.313 $3 393 Total Estimated sales commission ($3,393 . S650-$1.050) x 24% S 406 Consultants and Time Records Unlike the sales reps, the consultants were all paid a straight salary with no overtime and no bonus. Paukovich Consulting used a job costing system that required consultants to record their time in 0.25 hour (15-minute) incremcnts. Each project was assigned a job code and each task (survcy design, data collection, repot writing, proofreading, and copying and binding) was assigned a task code. The standard consultant labor ratc was equal to the average consultants' annual salaries divided by thcoretical capacity of 2,080 hours per year (standard work week of 40 hours times 52 weeks per year). Exhibit 3 provides average consultant time records from 20x2 Exhibit 3: Average Consultant Time During 20x2 Senior 1,500 410 110 Junior 1,000 960 100 Time charged to job:s Time charged to internal marketing llolidays and sick leave Vacation 2,080 Total hours 2,080 (52 weeks x 40 hours per week- 2,080 hours) VP of Finance Concerns Randall Smith, lhe vice president of finane, had two major concerns about the current system for sales reprcscntativcs and consultants. First, Randall noticed that some of the sales reps often brought in relatively small jobs. Hc wondered whether these small jobs were worth the resources devoted to them. He decided to talk with Richard about setting a minimun price on all jobs. Second, Randall found that the consultants bitled nearly half of their time to job code 0001 "Internal Marketing (see Exhibit 3). This job code was used for all marketing activities, including time spent helping the sales reps on proposals. However, he suspected that the senior and junior consultants did not assign equivalent work to this job code. Specifically, he believed that the sales reps prcfered to ask the senior consultants for help when writing proposals, to increase the chance of winning the bid. He also suspected that the sales reps had been pressuring the junior consultants to bill some of the time spent on projccts as "Internal Marketing" to avoid exceeding the time budget on projocts. Tunior consultants often took longer conpletc a project than the senior consultants. Since consultant performance was evaluated based on meeting budgets, the junior consultants generally complied with a sales rep's request. Randall planncd to recommend a revised time reporting system. Under the new system, consultants would not be permitted to charge time to "internal marketing." Instcad, they would charge their time separately to "job proposals" and to "unbillable time." The "unbillable time category would include time spent in departmental meetings, training courses, and other activities that cannot be traced to jobs. In addition, each consultant's time records would be submitted to a new consulting manager who would review and approve them. The consultants would be pressured to accurately report how their time is spent. Randall estimated the average consultant time under the new system as shown in Exhibit 4 Exhibit 4: Estimated Average Consultant Time nder Proposed Time Reporting System Senior Junior 1,720 40 200 100 Time charge ojobs Time charged to job proposals Unbillable time Holidays and sick leave Vacation 330 80 110 60 2,080 Total hours 2,080 Questions Cost Behavior and Cost Functiorn 1. Refer to the prior year income statements showm in Exhibit 1. Classify cach of the following costs as fixed, variable, or mixed. Briefly explain how you classified each item a. Sales representative commissions b. Payroll taxes and employee benefits c. Survey labor, printing, photocopying, and other direct job costs d. Rent, heat, and lights 2. Create a cost function for Paukovich Consng. Use the financial staterment infonmation in Exhibit l and your cost classifications from question #1. Assume that miscclaneous office costs are mixed. For simplicity, use revenues as the cost driver (Hint: Because only two years' data are available, use the two-point method to estimate the cost function for mixed costs.) Cost-Volume-Profit Analysis 3. Given your answer to question #2, what amount of revenue must the company generate to achieve net income (after-tax) of SS0O,000? Given your answer to question #2, calculate the company's 20x2 operating leverage. Should Rchard Paukovich be concemed about the company's degree of operating leverage? Explain. 4. 5. Given your answer to question #2, calculate the company's 20x2 margin of safety in revenue, and briefly explain what it means. Job Costing System 6. The consultants were paid on salary. Why would the company have them fill out time sheets? 7. Was it a problem that so much consulting time was charged to "Internal Marketing? Why or 8. Would management capture better infonmation if thc sales reps also completed time sheets? why nol? Explain. 9. Should the sales reps be responsible for estimating job costs? Why or why nol? 10. Critique the method used to calculate the standard consulting labor rate. Will it result in over- or under-applied labor cost? Who would bc affected by any misapplication? How might you change the standard cost system? Overhead/Support Cost Allocation I1. What types of overhead costs did the company incur? Should the accounting system be modified to allocate overhead to individual jobs? As you answer this quesrion, consider how allocated overhead cost information might be used 12. Suppose the owner decides that overhead costs should be allocated to each job. Recommend a support cost allocation method (textbook Chapter 8). Explain your choice. 13. Discuss whether activity-bascd costing (ABC) would be useful for Paukovich. Job Pricing 15. Discuss whether the company's pricing policy should be changed. In your discussion, consider the basis that should be used to set prices and who should be responsible for pricing decisions. 16. Consider the VP of Finance's idea that a minimum price should be established for all jobs Discuss the pros and cons of this idea. Internal Reporting Format 17. Would a variable costing income statement provide useful information to the management of Paukovich Consulting? Explain Employee Incentives 18. What were the incentives and likely behavior of the sales reps under the existing accounting ystem? 19. Should the sales rep commissions be based on the difference between the price and the ex-post (i.e., actual) consulting labor cost 20. What factors should be considered when evaluating the consultants' performanoe? Paukovich Consulting: The Case of the Unhappy Sales Force' Introduction Richard Paukovich, the owner and CEO of Paukovich Consulting, was late arriving to the company's weekly project status review meeting. Lately, he had dreaded these mcetings because they nearly always became shouting matches between the sales representatives and the consultants. He was disappointed in the lack of trust between the two parts of his company, but was at a loss about how lo improve morale and increase productivi This week's meeting was no exception. As he entered the conference room, Carol Barnet, scnior sales rep, was complaining that her most recent paycheck was short by over S500 and that it was probably because the Ecoba job was over budget. Carol was the leading complainer among the sales reps. She regularly pointed out that her monthly commission check was less than the estimated ommission Another sales rep, David Morion, chimed in. "Yes, Carol's right. The consultants always spend too much time on writing reports. And then projects are delivered late and the eustomers complain." Greg Bilton, the consultant assigned to the Ecoba job, retorted It's not our fault You sales reps always promise more than wc can deliver and you never budget enough time for projects. Ifyou did a better job of sctting customer expectations, then we could meet them." Richard spokc up, reminding Carol that "the reason that you and the other sales reps are paid from actual margins rather than forecast margins is to prevent you from expanding the scope of projects after they are sold and sneaking in extra work to the customers for free." After the meeting, CGreg grumbled privately to one of his consulting colleagues that c would be able to complete jobs on time if we knew which jobs would be coming in and if Richard didn't always pull us off other jobs to work on his projects." Paukovich Consulting Richard Paukovich had formed Paukovich Consuling 10 years earlier. The company provided customer satisfaction survey consulting services. Richard had developed a wide nctwork of client contacts, and he generated approximarely one third of the company's revenues. The remaining revenucs were generated by sales representatives The company was profitable for the owner, as shown in Exhibit 1 This case is based on a real company, but thc nac aud consulting niche have been changed to maintain confidentiality Exhibit: Prior Incomc Statements 20x2 20x1 Revenues $2,500,000 $2,000,000 Expenses President's salary Consultant salaries Sales representative commissions Other general and administrative salaries......... 50,000 290,000 180,000 135,000 Payroll taxes and employee benelits....252,000 150.000 270,000 200,000 130,000 231,000 Survey labor, printing, photocopying, and other direcr job costs Rent, heat, and lights Miscellaneous office costs 900,000 51,000 700,000 50,000 45.0 Total expenses Pretax incoime 771,000 229,000 497,000 Income tax expense @ 20% Net income 397,600 183,200 Project Pricing and Sales Commissions All sales reps werc responsible for writing their own proposals, although they could ask thc consultants for technical assistance as needed. The salcs reps were responsible for calculating the estimated cost and for setting the price for projects. After a turned each project over to a consultant to do the actual work. proposal was accepted, the sales reps The sales reps usually set the price at 320% of the estinored direct consulting labor cost plus 125% of the other direct costs (such as survey labor and photocopying). The estimated direct consulting labor cost was calculated by multiplying the estimated consulting hours by a standard labor ratc. A standard rate of S25 per hour was used for senior consultants, and a $20 ratc was used for junior consultants. The sales force was paid on straight sales commission. The commission was equal to 24% of the difference berween the price paid for a project by the client and the actual total direct costs of the project. After a project was complete, the actual labor hours were totaled and the actual direct consullant labor cost was calculated by multiplying actual hours times the labor rate. Other dircct costs were also accumulated for thejob. Then the sales rep's commission was calculated and paid. Exhibit 2 provides estimared cost, price, and commission information for a potential new jot 2 Exhibit 2: Potential New Job One of the sales rcpresentatives developed the following information for a potential new consuling erigagemcnt. Estimated consultant cost Scnior consultant Junior consultant 10 hours a $25 per hour 20 hours &$20 per hour 250 400 Total 650 Estimated other direct job costs Survey labor (outsourced) Photocopying of final report (outsourced) $1,000 Total S1050 Estimated price: Consultant cost Other direct costs $650 x 320% $ 1 ,050 x 1 25% $2,080 1.313 $3 393 Total Estimated sales commission ($3,393 . S650-$1.050) x 24% S 406 Consultants and Time Records Unlike the sales reps, the consultants were all paid a straight salary with no overtime and no bonus. Paukovich Consulting used a job costing system that required consultants to record their time in 0.25 hour (15-minute) incremcnts. Each project was assigned a job code and each task (survcy design, data collection, repot writing, proofreading, and copying and binding) was assigned a task code. The standard consultant labor ratc was equal to the average consultants' annual salaries divided by thcoretical capacity of 2,080 hours per year (standard work week of 40 hours times 52 weeks per year). Exhibit 3 provides average consultant time records from 20x2 Exhibit 3: Average Consultant Time During 20x2 Senior 1,500 410 110 Junior 1,000 960 100 Time charged to job:s Time charged to internal marketing llolidays and sick leave Vacation 2,080 Total hours 2,080 (52 weeks x 40 hours per week- 2,080 hours) VP of Finance Concerns Randall Smith, lhe vice president of finane, had two major concerns about the current system for sales reprcscntativcs and consultants. First, Randall noticed that some of the sales reps often brought in relatively small jobs. Hc wondered whether these small jobs were worth the resources devoted to them. He decided to talk with Richard about setting a minimun price on all jobs. Second, Randall found that the consultants bitled nearly half of their time to job code 0001 "Internal Marketing (see Exhibit 3). This job code was used for all marketing activities, including time spent helping the sales reps on proposals. However, he suspected that the senior and junior consultants did not assign equivalent work to this job code. Specifically, he believed that the sales reps prcfered to ask the senior consultants for help when writing proposals, to increase the chance of winning the bid. He also suspected that the sales reps had been pressuring the junior consultants to bill some of the time spent on projccts as "Internal Marketing" to avoid exceeding the time budget on projocts. Tunior consultants often took longer conpletc a project than the senior consultants. Since consultant performance was evaluated based on meeting budgets, the junior consultants generally complied with a sales rep's request. Randall planncd to recommend a revised time reporting system. Under the new system, consultants would not be permitted to charge time to "internal marketing." Instcad, they would charge their time separately to "job proposals" and to "unbillable time." The "unbillable time category would include time spent in departmental meetings, training courses, and other activities that cannot be traced to jobs. In addition, each consultant's time records would be submitted to a new consulting manager who would review and approve them. The consultants would be pressured to accurately report how their time is spent. Randall estimated the average consultant time under the new system as shown in Exhibit 4 Exhibit 4: Estimated Average Consultant Time nder Proposed Time Reporting System Senior Junior 1,720 40 200 100 Time charge ojobs Time charged to job proposals Unbillable time Holidays and sick leave Vacation 330 80 110 60 2,080 Total hours 2,080 Questions Cost Behavior and Cost Functiorn 1. Refer to the prior year income statements showm in Exhibit 1. Classify cach of the following costs as fixed, variable, or mixed. Briefly explain how you classified each item a. Sales representative commissions b. Payroll taxes and employee benefits c. Survey labor, printing, photocopying, and other direct job costs d. Rent, heat, and lights 2. Create a cost function for Paukovich Consng. Use the financial staterment infonmation in Exhibit l and your cost classifications from question #1. Assume that miscclaneous office costs are mixed. For simplicity, use revenues as the cost driver (Hint: Because only two years' data are available, use the two-point method to estimate the cost function for mixed costs.) Cost-Volume-Profit Analysis 3. Given your answer to question #2, what amount of revenue must the company generate to achieve net income (after-tax) of SS0O,000? Given your answer to question #2, calculate the company's 20x2 operating leverage. Should Rchard Paukovich be concemed about the company's degree of operating leverage? Explain. 4. 5. Given your answer to question #2, calculate the company's 20x2 margin of safety in revenue, and briefly explain what it means. Job Costing System 6. The consultants were paid on salary. Why would the company have them fill out time sheets? 7. Was it a problem that so much consulting time was charged to "Internal Marketing? Why or 8. Would management capture better infonmation if thc sales reps also completed time sheets? why nol? Explain. 9. Should the sales reps be responsible for estimating job costs? Why or why nol? 10. Critique the method used to calculate the standard consulting labor rate. Will it result in over- or under-applied labor cost? Who would bc affected by any misapplication? How might you change the standard cost system? Overhead/Support Cost Allocation I1. What types of overhead costs did the company incur? Should the accounting system be modified to allocate overhead to individual jobs? As you answer this quesrion, consider how allocated overhead cost information might be used 12. Suppose the owner decides that overhead costs should be allocated to each job. Recommend a support cost allocation method (textbook Chapter 8). Explain your choice. 13. Discuss whether activity-bascd costing (ABC) would be useful for Paukovich. Job Pricing 15. Discuss whether the company's pricing policy should be changed. In your discussion, consider the basis that should be used to set prices and who should be responsible for pricing decisions. 16. Consider the VP of Finance's idea that a minimum price should be established for all jobs Discuss the pros and cons of this idea. Internal Reporting Format 17. Would a variable costing income statement provide useful information to the management of Paukovich Consulting? Explain Employee Incentives 18. What were the incentives and likely behavior of the sales reps under the existing accounting ystem? 19. Should the sales rep commissions be based on the difference between the price and the ex-post (i.e., actual) consulting labor cost 20. What factors should be considered when evaluating the consultants' performanoe