Customer profitability and ethics. KC Corporation manufactures ...

[humphriesbr@me.com]

Customer profitability and ethics.
 
  KC Corporation manufactures an air-freshening device called GoodAir, which it sells to six merchandising firms. The list price of a GoodAir is 30, and the full manufacturing costs are 18. Salespeople receive a commission on sales, but the commission is based on number of orders taken, not on sales revenue generated or number of units sold. Salespeople receive a commission of 10 per order (in addition to regular salary).
   KC Corporation makes products based on anticipated demand. KC carries an inventory of GoodAir, so rush orders do not result in any extra manufacturing costs over and above the 18 per unit. KC ships finished product to the customer at no additional charge for either regular or expedited delivery. KC incurs significantly higher costs for expedited deliveries than for regular deliveries. Customers occasionally return shipments to KC, and the company subtracts these returns from gross revenue. The customers are not charged a restocking fee for returns.
  Budgeted (expected) customer-level cost driver rates are:
 
  Because salespeople are paid 10 per order, they often break up large orders into multiple smaller orders. This practice reduces the actual order-taking cost by 7 per smaller order (from 15 per order to 8 per order) because the smaller orders are all written at the same time. This lower cost rate is not included in budgeted rates because salespeople create smaller orders without telling management or the accounting department. All other actual costs are the same as budgeted costs.
 
  Information about KC's clients follows:
    Because DC places 20 separate orders, its order costs are 15 per order. All other orders are multiple smaller orders and so have actual order costs of 8 each.
 
  Required:
  1. Classify each of the customer-level operating costs as a customer output unitlevel, customer batch-level, or customer-sustaining cost.
  2. Using the preceding information, calculate the expected customer-level operating income for the six customers of KC Corporation. Use the number of written orders at 15 each to calculate expected order costs.
  3. Recalculate the customer-level operating income using the number of written orders but at their actual 8 cost per order instead of 15 (except for DC, whose actual cost is 15 per order). How will KC Corporation evaluate customer-level operating cost performance this period?
  4. Recalculate the customer-level operating income if salespeople had not broken up actual orders into multiple smaller orders. Don't forget to also adjust sales commissions.
  5. How is the behavior of the salespeople affecting the profit of KC Corporation? Is their behavior ethical? What could KC Corporation do to change the behavior of the salespeople?

Question 2

As equipment is depreciated, its book value increases and its accumulated depreciation increases.
  Indicate whether the statement is true or false

[ngr69]

Answer to Question 1

1. Order taking  Customer batch-level
Product handling  Customer output-unit-level
Delivery  Customer batch-level
Expedited delivery  Customer batch-level
Restocking  Customer batch-level
Visits to customers  Customer sustaining-level
Sales commissions  Customer batch-level

2. Customer-level operating income based on expected cost of orders:

Customers
AC DC MC JC RC BC
Revenues
30  225; 520; 295; 110; 390; 1,050 6,750 15,600 8,850 3,300 11,700 31,500
Less: Returns
30 15; 40; 0; 0; 35; 40 450 1,200 0 0 1,050 1,200
Net Revenues
30 210; 480; 295; 110; 355; 1,010 6,300 14,400 8,850 3,300 10,650 30,300
Cost of goods sold
18  210; 480; 295; 110; 355; 1,010 3,780 8,640 5,310 1,980 6,390 18,180
Gross margin 2,520 5,760 3,540 1,320 4,260 12,120
Customer-level operating costs:
Order taking
15 10; 20; 9; 12; 24; 36 150 300 135 180 360 540
Product handling
1  225; 520; 295; 110; 390; 1,050 225 520 295 110 390 1,050
Delivery
1.20  360; 580; 350; 220; 790; 850 432 696 420 264 948 1,020
Expedited delivery
175  0; 8; 0; 0; 3; 4 0 1,400 0 0 525 700
Restocking
50 3; 2; 0; 0; 1; 5 150 100 0 0 50 250
Visits to customers 125 125 125 125 125 125
Sales commissions
10 10; 20; 9; 12; 24; 36 100 200 90 120 240 360
Total customer-level operating costs 1,182 3,341 1,065 799 2,638 4,045
Customer-level operating income 1,338  2,419 2,475  521  1,622  8,075

3. Customer level operating income based on actual order costs:
Customers
AC DC MC JC RC BC
Revenues
30  225; 520; 295; 110; 390; 1,050 6,750 15,600 8,850 3,300 11,700 31,500
Less: Returns
30 15; 40; 0; 0; 35; 40 450 1,200 0 0 1,050 1,200
Net Revenues
30 210; 480; 295; 110; 355; 1,010 6,300 14,400 8,850 3,300 10,650 30,300
Cost of goods sold
18  210; 480; 295; 110; 355; 1,010 3,780 8,640 5,310 1,980 6,390 18,180
Gross margin 2,520 5,760 3,540 1,320 4,260 12,120
Customer-level operating costs:
Order taking
8 10; 15  20; 8  9; 8  12; 8  24; 8  36 80 300 72 96 192 288
Product handling
1  225; 520; 295; 110; 390; 1,050 225 520 295 110 390 1,050
Delivery
1.20  360; 580; 350; 220; 790; 850 432 696 420 264 948 1,020
Expedited delivery
175  0; 8; 0; 0; 3; 4 0 1,400 0 0 525 700
Restocking
50 3; 2; 0; 0; 1; 5 150 100 0 0 50 250
Visits to customers 125 125 125 125 125 125
Sales commissions
10 10; 20; 9; 12; 24; 36 100 200 90 120 240 360
Total customer-level operating costs 1,112 3,341 1,002 715 2,470 3,793
Customer-level operating income 1,408  2,419 2,538  605  1,790  8,327

Comparing the answers in requirements 2 and 3, it appears that operating income is higher than expected, so the management of KC Corporation would be very pleased with the performance of the salespeople for reducing order costs. Except for DC, all of the customers are more profitable than originally reported.

4. Customer-level operating income based on actual orders and adjusted commissions

Customers
AC DC MC JC RC BC
Revenues
30  225; 520; 295; 110; 390; 1,050 6,750 15,600 8,850 3,300 11,700 31,500
Less: Returns
30 15; 40; 0; 0; 35; 40 450 1,200 0 0 1,050 1,200
Net Revenues
30 210; 480; 295; 110; 355; 1,010 6,300 14,400 8,850 3,300 10,650 30,300
Cost of goods sold
18  210; 480; 295; 110; 355; 1,010 3,780 8,640 5,310 1,980 6,390 18,180
Gross margin 2,520 5,760 3,540 1,320 4,260 12,120
Customer-level operating costs:
Order taking
15 5; 20; 4; 6; 9; 18 75 300 60 90 135 270
Product handling
1  225; 520; 295; 110; 390; 1,050 225 520 295 110 390 1,050
Delivery
1.20  360; 580; 350; 220; 790; 850 432 696 420 264 948 1,020
Expedited delivery
175  0; 8; 0; 0; 3; 4 0 1,400 0 0 525 700
Restocking
50 3; 2; 0; 0; 1; 5 150 100 0 0 50 250
Visits to customers 125 125 125 125 125 125
Sales commissions
10 5; 20; 4; 6; 9; 18 50 200 40 60 90 180
Total customer-level operating costs 1,057 3,341 940 649 2,263 3,595
Customer-level operating income 1,463  2,419 2,600  671  1,997  8,525

5. The behavior of the salespeople is costing KC Corporation 588 in profit (the difference between the incomes in requirements 3 and 4.) Although management thinks the salespeople are saving money based on the budgeted order costs, in reality they are costing the firm money by increasing the costs of orders (1,028 in requirement 3 versus 930 in requirement 4) and at the same time increasing their sales commissions (1,110 in requirement 3 versus 620 in requirement 4). This is not ethical.

KC Corporation needs to change the structure of the sales commission, possibly linking commissions to the overall units sold rather than on number of orders.

Some students might argue that the amount is not material, but in matters of ethics be wary of the slippery slope. Most organizations do not stand for any deviation from ethical principles, regardless of the amount involved. Students can engage in an interesting debate around this point.

Answer to Question 2

F

[humphriesbr@me.com]

Correct answers!

[ngr69]

Great! Please up vote