Accounting Report_Prestige Telephone Company

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Prestige Telephone Company

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Course Subject: Accounting for Decision-making
Course Code

: GSM5301

Group

:8

Case Study : Prestige Telephone Company

Background of Case Study
In April 1997, president of Prestige Telephone Company (PTC), Daniel Rowe,
was making arrangements to meet with its computer data service subsidiary Prestige
Data Services’ (henceforth PDS) manager Susan Bradley. This subsidiary performs
data processing for the telephone company and sells computer services to other
companies. In 1994, Rowe suggested that productive computer services subsidiary will
decrease the telephone rate rise’s pressure, but it was still not profitable at the end of
1996. Rowe felt the need to cut down the company resources’ drain.

PDS grew out of PTC’s needs for computer services for its own operations for its
metropolitan region. Prestige realized that the metropolitan region’s other businesses
required like services and that centralized services can be given over telephone circuits
hinted that it could sell computer time that is not required by telephone operations.

Also, every public utility under the jurisdiction of the Public Service Commission
(PSC) were asked to find fresh resources of revenue for deregulation and to decrease
the need for increase in rates that higher costs would cause otherwise. Due to its
function as a public utility, the rates PTC charged could not be altered without PSC’s
approval. To present the new subsidiary’s proposal, Rowe put forth an argument for a
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unique but completely owned entity whose prices for service would not be regularized.
This is so that Prestige can contend with other organisations in an active field. Also,
profits for telephone services usage might also be raised. Subject to the mean monthly
charge for service by PDS to PTC not exceeding the cost of equivalent services used by
PTC which was estimated in 1994 ($82,000), the commission accepted the proposal.

PDS has been having problems since its inception in 1995 – delay in equipment
delivery; personnel demanding higher wages; difficulty in finding customers. When
PTC’s income had decreased so much requiring a report to shareholders showing the
lowest return on investment (ROI) in seven years in 1996, Mr Rowe wished to reassess
PDS. With the quarterly reports coming in, a meeting was arranged. He received two
reports on PDS’ operations. Firstly, the Summary of Computer Utilisation demonstrated
a lasting issue – the hours available which did not provide revenue continued being
high. Secondly, from the report on the revenue and cost data, Rowe went through the
costs and found that due to its relationship with PTC, PDS could prevent lots of costs
that an independent company has.

Despite the discouraging results, Rowe still believed that the subsidiary was too
good to abandon. Also, he was uncertain as to whether the accounting report truly
unveiled the contribution that PDS made to PTC. He felt that the accounting procedures
employed for individual activities within the company were haze over the costs and
benefits provided.

2

Upon studying the reports, he decided to analyse them to proceed to ask Bradley
to figure the likely outcomes on profits of raising the price to customers other than PTC,
decreasing prices, raising effort for sales and promotion, and of moving to two shifts
instead of 24 hour-operations.

3

Table of Content
Description

Page

Introduction

5-6

Question 1

7

Question 2

8

Question 3

9-12

Question 4

13

References

14

4

Introduction
Prestige Telephone Company’s top management is giving thoughts to the other courses
of action that could be taken in order to better the performance of its new subsidiary
namely Prestige Data Services. Originally, it was thought of as a means through which
high and unregulated returns can be employed to increase Prestige Telephone
Company’s profits at the same time rendering computer services to the company.

Although the performance of the subsidiary has not been up to par with the standards
expected of it, two years after the operation, Prestige Data Services finally came
through in coming in line with the services required by its parent company, and is selling
extra hours of capacity to customers from outsider at an escalating rate.

One of the important matters pertain to whether the reports which are currently being
prepared give out all the information that are needed in order to address the questions
the top management has put forth. If it is found that they do not, then what type of
analysis is able to aid with the decisions being looked into?

Although this case is rather direct, it gives a lot of data to study three things that are vital
for an effective management accounting. These are firstly, to study the operations’
results are they were reported, and to comprehend the source and type of receipts,
revenues, expenditures and expenses; secondly, to form a comprehension of a
business’ economics and to utilise said comprehension in order to predict the likely
change in income which would take place if several courses of action were chosen by
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management; thirdly, to comprehend the significance of the manner in which cost
information is reported, and the manner in which accounting and reporting systems can
be employed to emphasise on the ingredients that are vital to management and for
operations’

appraisal.

This report aspires to sum up all the outcomes of the investigation on this company. For
every issue raised here, recommended resolutions are submitted as well. Every finding
serves the objective in order to proceed with the wise and informed decision-making
process.

6

Answer to Question 1
An assessment of PDS’ outcomes were carried out using Exhibit No 2 which is a
summary of its operations in 1997’s first quarter. It showed that fixed and variable costs
were in the report. Nevertheless, based on accounting customary rules, variable costs
are the only costs that ought to be taken into account in decision-making processes. In
addition, the opportunity cost of the rentals for the computer equipment, which
possessed four years more and cannot be cancelled anymore. The aim of the company
was to drive in the path of deregulation that would consequently diminish the necessity
for an increase in rate. Furthermore, assuming PDS was to be shut down, an outside
company would have to be hired to render this service to PTC with revenue loss from
commercial sales. Pertaining to the space that PDS is presently utilizing, the space
could be leased out to an outside company. Also, the personnel could be laid off so that
there will be no need to pay for salaries and wages.

Apart from that, it is evident that the loss diminished from January to March. This can be
seen from Exhibit 2 and it is expected to turn into gains for the company in the nearest
future. In this matter, the primary issue is that only a short-term standpoint to financial
outcomes such as from January to March has been given attention to. One cannot
resolve anything solely based on said short-term standpoint. Serious decisions such as
retention or shutdown particularly cannot be made on the basis of such short-term
projections. In conclusion, continuing PDS is more effective than closing it down
because it could become a money-spinner in a time to come.

7

Answer to Question 2
For calculating the level of commercial sales of computer use, we need to determine
fixed and variable costs. The only variable costs were power and part of operations
salaries.
The total power cost for all three months is = ($1633+ $1592+$1803) = $5028
The computers were is use for 1110 hours
So, the Variable cost – Powers Cost per hour

= $5028/ 1110 hours = $4.53

Total operations expense = $88,944
Total hours of computer use = 1110 hours
So, the variable cost – operations wages is = $88944/ 1110 = $80.13
Here, the contribution margin is

= (Selling Price – Variable cost per unit)
= $800 – ($4.53 + $80.13) = $715.34

According to the case study, Prestige Telephone Company has an agreement with the
Prestige Data Service to cover $82,000 of the costs.
Using this assumption and that mentioned in the above paragraph, we have calculated
the following break-even analysis= Total Fixed Costs – (Cost Covering by PTC – Average monthly hours X Variable cost
per unit) / Contribution Margin
= 200,396– (82000- 205 X84.66) / 715.34
= (200,396 – 64,644.7) / 715.34
= 189.77 (estimated) hours

8

Taking 189.77 hours times the $800 per hour for commercial sales would result in break
even revenue of $151,817 that would be necessary each month.

Answer to Question 3
Estimated the effect on income of each of the operations Rowe has suggested if
Bradley estimates as follows:
a Increase the price to commercial customers to $1,000 per hour would reduce
demand by 30 percent.
Let’s say that the power cost can be estimated about $4.50 per hour and the
variable portion of the operations wages at $24 per hour.
Each of the sets of assumptions in Question #3 in the case offers the opportunity
to analyze the effects of possible changes in demand due to changing price,
promotion or operating conditions. The analyses are dependent upon the cost
analysis previously completed. Once that analysis is accepted, each calculation
is straightforward. A summary follows:
When the price of commercial customers is increase to $1,000 per hour it would
reduce demand by 30%. Demand was for 138 hours for the month of March
1997, and by calculation of 30% reduction from the commercial revenue hours
as the following:
30% Reduction of demand = 138 hours x 0.7 = 96.6 hours ~ 97 hours
Calculate the impact of increasing the price to commercial customer:
Contribution = Demand x Contribution per hour (power cost & operation wages)
= 97 hours x ($1,000.00 - $4.50 - $24.00) = $94,236.00
Compare to March data:
Contribution = Demand x Contribution per hour (power cost & operation wages)

9

= 138 hours x ($800.00 - $4.50 - $24.00) = $106,467.00

10

The cost difference between before & after:
Contribution (In March) – Contribution (30% Reduce)
= $106,467.00 - $94,236.00
= $ 12,231.00 / mth
When comparison between the two is made, it found that the fixed costs and
income at $800 is greater by $12,231 than the contribution expected at $1,000.
Conclusion: It is better to maintain the income at $800 because it will be higher
as compare with $1,000.

b Reducing the price to commercial customers to $600 per hour would increase
demand by 30 percent.
Base on March 1997, demand was for 138 hours, so that a 30% increase would
give demand as the following:
30% Increase of demand = 138 hours x 1.3 = 179.4 hours ~ 179 hours
Calculate the impact of reducing the price to commercial customer:
Contribution = Demand x Contribution per hour (power cost & operation wages)
= 179 hours x ($600.00 - $4.50 - $24.00) = $102,299.00
Compare to March data:
Contribution = Demand x Contribution per hour (power cost & operation wages)
= 138 hours x ($800.00 - $4.50 - $24.00) = $106,467.00

11

The cost difference between before & after:
Contribution (In March) – Contribution (30% Reduce)
= $106,467.00 - $102,299.00
= $ 4,169.00 / mth.
When comparison between the two is made, it found that the fixed costs and
income at $600 reduces the profit by $4,169/mth than the contribution expected
at $800. Conclusion: It is better to maintain the income at $800 because it will be
higher as compare at $600.

c

Increased promotion would increase sales by up to 30 percent. Bradley is unsure
how much promotion this would take. (How much could be spent and still leave
Prestige Data Services with no reported loss each month if commercial hours
were increased 30 percent?)
An increase in promotion that would increase commercial sales by 30% would
increase sales to 179 hours per month.
At $800 per hour, the total contribution would be:
179 hours x ($800.00 - $28.59) = $138,099.00
Difference between the targeted promotion requirements:
= $138,099.00 - $106,467.00
= $31,632.00
An amount up to the difference between this new contribution and the present
contribution of $106,467.00 or $31,632.00 could be spent without reducing
income.
12

d Reducing operations to 16 hours on weekdays and eight hours on Saturdays
would result in a loss of 20 percent of commercial revenue.
Reducing hours would reduce demand for commercial revenue hours by 20%,
from 138 hours to 110 hours.
At that level, the total contribution would be:
110 hours x ($800.00 - $28.50) = $84,865.00 or $21,602.00 less than at present.
But what expenses could be saved? Except for operations wages (and perhaps
materials and supplies) it appears most other expenses would not be affected by
this reduction of service and revenue. $21,600.00 of operating wages are
nonvariable, so perhaps one-third of that could be eliminated by going on twoshift operations rather than three shifts. Savings of $7,200.00 hardly offsets a
loss of contribution of $21,602.00, so the option of giving up a shift appears not
very attractive.

13

Answer to Question 4
There are some cost inefficiencies in the method currently used. Due to these
inefficiencies embedded in the value of service provided, they are not fairly reflected in
the revenue and expenses statement. Thus, the resourcing model is a committed model
due to its fixed capacity costing elements.
In this way, Prestige Data Services will be able to get a more accurate and quantitative
data for cost allocation, finally, they will also be able to measure the amount of computer
and resources time being spent on Prestige Telephone Company compared with the
usage of other commercial customer. This changes to the accounting and reporting
system would reflect a fairer view of the results and be of more use to Rowe and
Bradley.

14

References:
Accounting for Decision Making; McGraw-Hill Education (Asia)
Harvard Business School Case 197-097; Harvard College

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