The analysis of the 2004 first quarter reports, which include the Summary of Computer Utilization and Summary Results of Operation, if is clear that the Data Services division needs to be scrutinized to understand why they continue to operate at a loss. The key areas that need to be addressed are: * Current utilization of computer usage hours * The consistent negative results of the operations * Determine if some of the fixed costs can be tied to the level of work and converted to variable costs The immediate concern is the portion of expenses that are fixed costs versus variable costs.
Variable costs equal $32,640 our analysis begins with careful inspection of the variable and fixed costs of Salem Data Services. It is clear the variable costs averaging $32,640 over the first quarter is not sufficient to overcome the current fixed costs which equal $189,620. The company should review the salaries for the Sales division and create a pay structure that is tied to revenue and sales.
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Additionally, sales promotion can also be tied to sales or revenue to convert these to variable costs.
The second major issue that needs to be addressed is the under utilization of the computer hours available versus computer hours used. The company is currently averaging about 60% utilization of available hours. The Commercial sales are seriously underutilized and needs to be a focus to driving commercial sales. Commercial demand may need to be re-assessed to determine if there is indeed a big enough market to serve and a review of the sales promotion strategy may need to be restructured. Overall, there is the possibility of Salem Data Services becoming a profitable subsidiary of Salem Telephone Company.
Shutting down the division is premature and rather the organization needs to re-visit the promotion and sales strategy to focus on increasing commercial sales and maximize the utilization of their computer hours. Furthermore, converting sales and sales promotion to variable costs may also prove to be a motivation to the sales staff to push sales harder to achieve additional customers. Analysis Salem Data Services Summary of Computer Utilization indicates that Salem Data Services average 60% or 132 hours of computer utilization.
This information along with the Results of Operations, which indicates an average loss of $35,327, raises serious concerns regarding the operations. A review of the expenses brings to the forefront that fixed costs are $189,620 and average variable costs are $32,640. Based on this information, the division average contribution margin is very good at of $154,292 or 82. 5%. Further analysis of the variable costs produces concerns regarding the allocation of corporate services. Total variable cost per hour is $97. 34 and corporate services makes up $45. 74 per hour, almost 50% of the total.
This warrants an evaluation on how corporate costs are allocated. The current allocation basis is cost per square foot. The fact that variable costs are relatively low lends some justification to having the subsidiary continue. Converting additional costs to variable costs and re-assessing the allocation basis may result in better results for the organization. Questions: 1. Which expenses in Exhibit 2 are variable with respect to revenue hours? Which expenses are fixed costs with respect to revenue hours? 2. For Each cost that is variable with respect to revenue hours, calculate per revenue hour. . Create a contribution margin income statement for Salem Data Services. Assume the Intracompany usage is 205 hours. Assume Commercial usage is at the March level. 4. Assuming the intracompany demand for service will average 205 hours per month, what level of commercial revenue hours of computer use would be necessary to break even each month? 5. Estimate the effect on Income of each of the option