LA CONSOLACION COLLEGE OF MANILA

Graduate School of Business

Managerial Accounting
Case Studies Ch. 16 – 2

Presented by:
Group 1

Bobis, Nova Amor

Castro, Carl Francis
Pascual, Kate-Lyn
2

Prestige Telephone
Company
  1.) Identify the costs that are relevant to the analysis to
3 discontinue Prestige Data Services:

 Relevant costs in the analysis by Prestige Telephone Co.

Decision to discontinue Prestige Data Services include: fixed
costs which must be absorbed by the parent company
(Prestige Telephone Co.) upon shutdown; outstanding
Prestige Data Services debts; costs of retraining retained
employees; costs associated with outsourcing data
previously provided by Prestige Data Services; opportunity
cost of using space rented to Prestige Data Services ;
marketing costs attributed to acquiring additional Prestige
Data Services customers; costs of increasing promotional
activites of Prestige Data Services . In Addition, Prestige
Telephone Co. Should consider the qualitative cost of
reduced employee morale which may result upon shutdown
of Prestige Data Services.
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2. Justify why each of the costs in item 1 is relevant:

The costs listed above are all relevant because they each vary with the shutdown
decision.

- Fixed Costs which must be absorbed by the parent co. (Prestige Telephone) upon
shutdown: Payroll, billing, collections, and other corporate services were provided by
Prestige Telephone in return for an amount from Data Services based on wages and
salaries. These fixed costs allocated to prestige Data Services must now be accounted
for by the parent company.

- Costs of retraining employees: If employees are retained by Prestige Telephone,

wages and salaries that were previously incurred by the Data Services line will hit
Prestige Telephone’s Budget. Also, new skills will be required of employees retaine dby
the company as well as accompanying training expenses.
5

- Costs associated with outsourcing data services previously provided by Prestige Data
Services: Prestige Telephone will still require the services Prestige Data Services supply, thus will
need to outsource them. Since Prestige Telephone was using a price cap based on estimated
data usage in 1999, they were effectively getting discounted data service rates from the
subsidiary. If Data Services is shut down, the company might incur much higher service
expenses.

- The maintenance cost is relevant because if Data Sevices is shut down the company will no
longer incur this costs, thus it needs to be considered as a cost the parent company can
eliminate.

- Opportunity cost of using space rented to Prestige Data Services: If Prestige Telephone
decides to shut down the Data Services Company, the parent company will lose the $8,000.00
monthly rental fee paid by the current subsidiary. Additionally, Prestige Telephone must consider
the opportunity cost of renting cost of renting the space to another company or service that may
provide them with more income.
6

- If Prestige Data Services is shut down, marketing costs

attributed to acquiring additional Prestige Data Services
customers and promotional activities will no longer be necessary.

- Termination of Prestige Data Services employees as a result

of shut down may reduce the morale of any retained employees
or employees of the parents company. Prestige might experience
decreased productivity or increased turnover as a result.
7

3.) Identify the costs that are NOT relevant to the analysis to discontinue Prestige
Data Services:

Costs not relevant to the decision are sunk costs such as the costs of training
Prestige Data Services employees, investments in the IT infrastructure, and any
owned Prestige Data Services Equipment. In addition, the fixed portion of the
electricity costs is not relevant. Depreciation costs are also not relevant.
The leases for computer equipment are non-cancelable and therefore may be
considered sunk costs because because Data Services is expected to cover the
costs associated with the leases prior to being shutdown. However if Prestige Data
Services is unable to pay off the leases, these costs will become relevant because
the parent company, Prestige Telephone would be responsible for debts owed.
8

 4.) Justify why each of the costs in item 3 is not relevant

 Fixed cost: Costs of equipment and fixtures are incurred whether or not Prestige
Data Service continues to operate. Even if the subsidiary company is shut
down, these fixed costs must still be taken into consideration.

 Some costs, such as electricity, whether used or not, will be charged for a
certain basic amount every month and therefore should not be considered
relevant.

 Depreciation is not relevant because cost of equipment is a sunk cost. There is

no significant salvage value for the equipment.
9

 5.) Identify the revenues that are relevant to the analysis to

discontinue Prestige Data Services:
 Revenues relevant to the analysis to discontinue the operation are
commercial sales revenue which includes computer use and other.

 6.) Justify why the revenues in item 5 are relevant:

 The revenues in item 5 differ across alternatives. In other words,
these revenues are directly tied to Prestige Data Services. If the
production capacity of Prestige Data Services decreases to zero, all
the revenue resulting from these operations will also decrease to $0,
which decreases the subsidiary’s contribution to its parent company.
  7.) Identify the revenues that are NOT relevant to the analysis to
10 discontinue Prestige Data Services.
 The revenue of Prestige Telephone and the revenue from
intercompany Sales are not relevant to the decision.

 8.) Justify why the revenues in item 7 are NOT relevant.

 As we explained in item 6, all revenues from Prestige Data
Services will change depending on the decision. As the production
capacity is varied, all the revenues will vary. These changes show
the expected overall effect on net income.
 Revenue at Prestige Data Service because Prestige Telephone’s
revenue is not tied to the operations of the subsidiary.

 From the perspective of the Parent Company, Intercompany

Sales are a revenue stream for the subsidiary, but an equal cost to
the parent, thus it doesn’t affect the balance sheet of the parent
company.
  9.) Is Prestige Data Services really a problem to the parent company?
11
 Prestige Data Services is not a problem to the parent company. This is
primarily because:
 - Prestige Telephone will have to pay higher rates for services
previously provided by Prestige Data Services.
 - Prestige Telephone will have to pay higher rates for services
previously provided by Prestige Data Services.
 Regardless of possible sunk costs such as equipment
leases(95,000.00), Prestige Data Service positively contributes to the
parent company.
 Additionally, if Prestige Data Services were to charge Prestige
Telephone the same rates ($800 per service hour) it charges for
commercial services, the company would not be operating at a loss. If
these commercial rates are considered competitive then the subsidiary is
saving its parent money.
 Furthermore, there are several strategies that can be implemented to
increase the business value of Prestige Data Services, such as reducing
computer usage.


 Prestige Data Services
Income Statement
For the months ended January 31, February 28 and March 31, 2003

12
Revenues January February March
Intercompany sales $ 82, 400.00 $ 72, 400.00 $ 89, 200.00

Commercial Sales 107, 641.00 117, 184.00 123, 085.00

Net Revenue $ 190, 041.00 $189,584.00 $ 212, 285.00

Less: Variables
Costs
Power $ 1, 633.00 $ 1,592.00 $ 1, 803.00

Wages & Sal.-Optns 29, 496.00 29, 184.00 30, 264.00

Materials 9,031.00 8,731.00 10, 317.00

Sales Promotions 7, 909.00 7, 039.00 8, 083.00

Corporate Services 15, 424.00 15, 359.00 15, 236.00

Total Variable Costs $ 63, 493.00 $ 61, 905.00 $65, 703.00

Contribution $ 126, 548.00 $ 127, 679.00 $ 146, 582.00

Margin
 Prestige Data Services
13 Income Statement
For the months ended January 31, February 28 and March 31, 2003

January February March

Contribution Margin $ 126, 548.00 $ 127, 679.00 $ 146, 582.00

Less: Fixed Costs

Space Costs $ 9, 240.00 $ 9, 240.00 $ 9, 240.00

Equipment Costs 126, 580.00 126, 580.00 126, 580.00

Wages & Salaries:

Systems Devpt & 12, 000.00 12, 000.00 12, 000.00

Maint.
Administration 9,000.00 9,000.00 9,000.00

Sales 11, 200.00 11, 200.00 11, 200.00

Total Fixed Costs $ 168, 020.00 $ 168, 020.00 $ 168, 020.00

Net Income (Loss) $ (41, 472.00) $ (40, 341.00) $ (21, 438.00)