Haley Romeros had just been appointed vice president of the Rocky Mountain Regio
ID: 2719806 • Letter: H
Question
Haley Romeros had just been appointed vice president of the Rocky Mountain Region of the Bank Services Corporation (BSC). The company provides check processing services for small banks. The banks send checks presented for deposit or payment to BSC, which records the data on each check in a computerized database. BSC then sends the data electronically to the nearest Federal Reserve Bank check-clearing center where the appropriate transfers of funds are made between banks. The Rocky Mountain Region has three check processing centers, which are located in Billings, Montana; Great Falls, Montana; and Clayton, Idaho. Prior to her promotion to vice president, Ms. Romeros had been the manager of a check processing center in New Jersey.
Immediately after assuming her new position, Ms. Romeros requested a complete financial report for the just-ended fiscal year from the region’s controller, John Littlebear. Ms. Romeros specified that the financial report should follow the standardized format required by corporate headquarters for all regional performance reports. That report follows:
Bank Services Corporation (BSC)
Rocky Mountain Region
Financial Performance
Check Processing Centers
*Local administrative expenses are the administrative expenses incurred at the check processing centers.
‡Corporate administrative expenses are charged to segments of the company such as the Rocky Mountain Region and the check processing centers at the rate of 9.5% of their sales.
No, the Clayton facility has had a nice profit every year since it was opened six years ago, but Clayton lost a big contract this year.
One of our national competitors entered the local market and bid very aggressively on the contract. We couldn’t afford to meet the bid. Clayton’s costs—particularly their facility expenses—are just too high. When Clayton lost the contract, we had to lay off a lot of employees, but we could not reduce the fixed costs of the Clayton facility.
Why is Clayton’s facility expense so high? It’s a smaller facility than either Billings or Great Falls and yet its facility expense is higher.
The problem is that we are able to rent suitable facilities very cheaply at Billings and Great Falls. No such facilities were available at Clayton; we had them built. Unfortunately, there were big cost overruns. The contractor we hired was inexperienced at this kind of work and in fact went bankrupt before the project was completed. After hiring another contractor to finish the work, we were way over budget. The large depreciation charges on the facility didn’t matter at first because we didn’t have much competition at the time and could charge premium prices.
Well we can’t do that anymore. The Clayton facility will obviously have to be shut down. Its business can be shifted to the other two check processing centers in the region.
I would advise against that. The $1,200,000 in depreciation at the Clayton facility is misleading. That facility should last indefinitely with proper maintenance. And it has no resale value; there is no other commercial activity around Clayton.
If we shifted Clayton’s business over to the other two processing centers in the region, we wouldn’t save anything on direct labor or variable overhead costs. We might save $90,000 or so in local administrative expense, but we would not save any regional administrative expense and corporate headquarters would still charge us 9.5% of our sales as corporate administrative expense.
In addition, we would have to rent more space in Billings and Great Falls in order to handle the work transferred from Clayton; that would probably cost us at least $600,000 a year. And don’t forget that it will cost us something to move the equipment from Clayton to Billings and Great Falls. And the move will disrupt service to customers.
I understand all of that, but a money-losing processing center on my performance report is completely unacceptable.
I can explain a write-off to corporate headquarters; hiring an inexperienced contractor to build the Clayton facility was my predecessor’s mistake. But they’ll have my head at headquarters if I show operating losses every year at one of my processing centers. Clayton has to go. At the next corporate board meeting, I am going to recommend that the Clayton facility be closed.
What costs and benefits are relevant in the decision to shut down the Clayton facility? (Enter decreases or reductions with a minus sign.)
What would be the net operating income of Rocky Mountain Region if Clayton Processing centre is shut down? Note: Ignore the costs of moving equipment and potential loss of revenues.
What is the impact on performance of Rocky Mountain Region if Clayton Processing centre is shut down? Note: Ignore the costs of moving equipment and potential loss of revenues.
Immediately after assuming her new position, Ms. Romeros requested a complete financial report for the just-ended fiscal year from the region’s controller, John Littlebear. Ms. Romeros specified that the financial report should follow the standardized format required by corporate headquarters for all regional performance reports. That report follows:
Explanation / Answer
Answer
What costs and benefits are relevant in the decision to shut down the Clayton facility
The original cost of the facilities at Clayton is sunk cost and sunk cost is not considered in any decision making. The decision being considered here is whether to continue the operations at clayton.
The only relevant costs are the future facility costs that would affected by this decision. If the facility is shut down, the Clayton facility has no resale value. In addition, if there Clayton facility were sold, the company would have to rent additional space at the remaining processing centers. On the other hand, if the facility were to remain in operations, the building should last indefinitely, so the company does not have to be concerned about eventually replacing it. Essentially, there I s no real cost at this point of using clayton facility despite what the financial report indicates. It might be a good idea to shut down the other facilities because rent on those facilities might be avoided.
What is the impact on overall profits of FSC if Clayton Processing centre is shut down
This will lead overall decline profits of FSC
The cost that is relevant in decision making to shut down
Increase in rent at Billings and Great falls $600,000
Decrease in administrative expenses ($90,000)
Net increase in costs $510,000
In addition, there would be costs of moving equipment from Clayton and there might be some loss on sales due to disruption of services. In short, closing down of Clayton would lead to a decline in profits
What would be the net operating income of Rocky Mountain Region if Clayton Processing centre is shut down? Note: Ignore the costs of moving equipment and potential loss of revenues
Financial performance After Shutting down the Clayton faciltiy
Total
Sales $50,000,000
Selling and Administrative expenses
Direct labor 32,000,000
Variable overhead 850,000
Equipment Depre 3,900,000
Facility exp 2,300,000
Local admin expense 360,000
Regional admin expense 1,500,000
Coprorate admin expense 4,750,000
Total Operating expense 45,660,000
Net operating income $4,340,000
Facility exp 2300000(2800000-1100000+600000)
Local admin expense $450,000-$90,000
What is the impact on performance of Rocky Mountain Region if Clayton Processing centre is shut down
Even though closing down of Clayton facility would result in overall company’s profits. It would result in increase performance report for Rocky Mountain region (ignoring cost of moving equipment and loss from disruption of services to customers).
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