Managerial Accounting Case Study 1: Salem Telephone Company Group 1

96122050 劉正雋
96122051 96122052 張淞傑 黃振修
96122073 陳柳伊96122085 黎全成
96122088 96122092 徐美玲 葉舒瑜
Through our study of Salem Telephone Company (STC), we’re going to answer that if Salem Data
Services (SDS) is really a profitable business to keep by using break-even point analysis. Before we
come out the final solution, let’s discuss SDS’ accounting report step by step.

First, we have to divide the various costs incurred in SDS into two types: variable costs and fixed costs.
From Exhibit 2 we can see that only “Power” and “Operations: hourly personnel” are variable costs
that have relation to the total revenue hours. Other expenses listed in Exhibit 2 are all fixed costs (Q1).
Besides, we can calculate the unit variable costs per revenue hour as follows (Q2):

January February March

Power 1,546 1,485 1,697
Operations: hourly personnel 7,896 7,584 8,664
Total variable costs 9,442 9,069 10,361
Total revenue hours 329 316 361
Variable costs per revenue hour 28.70 28.70 28.70

Furthermore, by distinguish the variable costs and fixed costs, we can construct the contribution margin
income statement for SDS at March level, assuming 205 hours for intracompany usage (Q3):

Revenues
Intracompany 82,000
Commercial 110,400
Total Revenues 192,400
Variable expenses (power + hourly personnel) 9,844
Contribution margin 182,556
Fixed expenses
Rent 8,000
Custodial services 1,240
Computer leases 95,000
Maintenance 5,400
Depreciation 26,180
Salaried staff 21,600
System development 12,000
Administration 9,000
Sales 11,200
Sales promotion 8,083
Corporate services 15,236
Total fixed expenses 212,939
Net income -30,383

Based on above assumptions, we can obtain the number of commercial revenue hours as follows:
(205 × 400 + x × 800) − 28.7 × (205 + x) − 212939 = 0 212939 − 82000 + 5884
x= = 177.39 ≅ 178
82000 + 800 x − 5884 − 28.7 x − 212939 = 0 800 − 28.7

Therefore, SDS needs to serve at least 178 commercial hours to break even (Q4).

(Q5) According to Flores’ suggestion, if commercial price is increased to $1000, the demand reduces
30%, then the effect on net income will be:
x = 138 × (1 − 0.3) ≅ 97
(205 × 400 + 97 ×1000) − 28.7 × ( 205 + 97) − 212939 = −42606

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Managerial Accounting Case Study 1: Salem Telephone Company Group 1

On the other hand, if the commercial price is reduced to $600, the demand increases 30%. The result of
net income will be:
x = 138 × (1 + 0.3) ≅ 180
(205 × 400 + 180 × 600) − 28.7 × (205 + 180) − 212939 = −33989

Another suggestion is to increase 30% commercial hours by increasing sales promotion. In such way,
the extra costs from promotion should not exceed:
x = 138 × (1 + 0.3) ≅ 180
(205 × 400 + 180 × 800) − 28.7 × (205 + 180) − 212939 = 2012

(Q6) Now we discuss the two approaches suggested by Flores:

1. Use pricing strategy to increase commercial revenue hours

This method will not add extra costs. However, according to our estimation above, changing
price to either $1000 (97 hours) or $600 (180 hours) can not prevent a net loss.
2. Increase sales promotion cost to win more business but the price unchanged

If SDS wants to increase 30% of commercial sales, the extra promotion costs can not be
exceed $2012. Considering the promotion cost $8083 on March, additional $2012 is roughly
24.9%. That is, SDS can only increase 25% promotion cost to achieve 30% of growth.

Based on our analysis, SDS has large fixed costs so that it’s not easy to profit. However, SDS still has
chances to profit but need great efforts, which we’ll mention later.
If SDS does not exist, STC has to purchase 205 intracompany hours from other companies at market
price $800, which costs $164000. In the meantime, STC also saves some costs if SDS closed:
Fixed expenses
Rent 8,000
Maintenance 5,400
Power 1,697
Salaried staff 21,600
Hourly personnel 8,664
System development 12,000
Administration 9,000
Sales 11,200
Sales promotion 8,083
Total saved expenses 85,644
Outsourcing costs 164,000
Extra cost if close SDS -78,356

STC can only save $85644 by closing SDS, but it needs to spend $164000 to purchase service from
outside. In other words, STC needs to pay extra $78356 if SDS does not exist. Therefore STC should
keep SDS business.
Since SDS is essential to keep, the first priority of SDS’ goal is to break even, at least. We recommend
Cynthia Wu to combine both Flores’ suggestions. That is, both increase the promotion budget and also
reduce price, which will make SDS become profitable more easily.