FAR EASTERN UNIVERSITY - MAKATI

GRADUATE STUDIES
MASTER IN BUSINESS ADMINISTRATION
MANAGEMENT ACCOUNTING

CASE STUDY: THE PRESTIGE TELEPHONE COMPANY

SUBMITTED BY GROUP 2
MEMBERS:

ARIVAN, JOHN DANTE

BAUTISTA, ROWENA
COLOMA, IANA CHRISTINE
DUY THANG, PHAM (JOSEPH)
GAMOS, MARIA EMILY
LEE, KASIAN
RODRIGUEZ, RICHES
URFANO, KATRINA JOIE

SUBMITTED TO:
MR. CHRISTOPHER HISO
Prestige Telephone Company

I. Background Information

Past
The Prestige Data Services is a subsidiary of Prestige Telephone Company (parent) which the primary
role is to perform data processing for the telephone company and to sell computer services to other
companies or organizations.

In 1994, the Prestige Data Services (subsidiary/ company) started its operations when Mr. Rowe told
the commission that a profitable computer services subsidiary would help reduce pressure for
telephone rate increase where Mr. Rowe had argued that having a wholly owned entity or subsidiary
whose services won’t be regulated would help the parent company compete with other computer
service organizations and additional revenues for use of telephone services.

Present
However, by the end of 1997 the subsidiary had yet to experience a profitable month. Since the first
year of the subsidiary’s operations they have encountered a lot of problems including late deliveries
of equipment, personnel commanding higher salaries, and also having trouble in finding costumers
than they have estimated in their initial expectation. The income of Prestige Telephone Company
was low enough to necessitate a report to shareholders revealing the lowest return on investment in
7 years.

Susan Bradley thinks that the company needs more time while Mr. Rowe feels it is time reassess
Prestige Data Services which may lead to its closure. But Mr. Rowe felt that there is a possibility the
accounting reports do not reveal the contribution of Prestige Data Services has provided and also
procedures used in accounting for separate activities in the company tended to obscure the costs
and benefits they provided.

Future

The subsidiary company has been established to help increase revenues for its parent company the
Prestige Telephone Company as a wholly owned entity whose price for service won’t be regulated.

Current Financial Standing of the Company

EXHIBIT 1 Prestige Data Services Summary of Computer Utilization, First Quarter 1997

Revenue Hours January February March Total

Intercompany 206 181 223 610
Commercial 123 135 138 396
Total revenue hours 329 316 361 1006
Service hours 32 32 40 104
Available hours 175 188 167 530
Total hours 536 536 568 1640

Total hours of revenue 361 348 401 1110

Available hours/ unutilized 175 188 167 530
 EXHIBIT 2 Prestige Data Services Summary Results of Operations, First Quarter 1997

Revenues: January February March

Intercompany sales ($400/HR.) 82,400 72,400 89,200
Commercial sales ($800/HR.)
Computer use 98,400 108,000 110,400
Other 9,241 9,184 12,685
Total Revenue 190,041 189,584 212,285
Expenses:
Space costs:
Rent 8,000 8,000 8,000
Custodial services 1,240 1,240 1,240
9,240 9,240 9,240
Equipment costs:
Computer leases 95,000 95,000 95,000
Maintenance 5,400 5,400 5,400
Depreciation:
Computer equipment 25,500 25,500 25,500
Offi ce Equipment and fixtures 680 680 680
Power 1,633 1,592 1,803
128,213 128,172 128,383
Wages and Salaries:
Operations 29,496 29,184 30,264
Systems development and maintenance
12,000 12,000 12,000
Administration 9,000 9,000 9,000
Sales 11,200 11,200 11,200
61,696 61,384 62,464
Materials 9,031 8,731 10,317
Sales promotions 7,909 7,039 8,083
Corporate services 15,424 15,359 15,236
Total expenses 231,513 229,925 233,723

Net Income(loss) (41,472) (40,341) (21,438)

II. Problem Statement

In terms of benefits, is the company worth keeping supporting the parent company Prestige
Telephone Company?

In order to assess such statement, the group have analysed the different types of cost
particularly variable, fixed and mixed cost.

With the current situation of the company, there is doubt as to the continuity of the business as
well as its growth opportunity. In order to assess such, information below should be looked into
for future planning and strategy:

Threats/ Limitations:
 Increase in rates of the company is subject to approval of the Public Service Commission
thus the company cannot increase such fees on their own or on their free will.
  The subsidiary can only charge $82,000 for services rendered to the parent company at $400
per hour or only equivalent to 205 hours.
 Computer equipment leases had 4 years to run and are non-cancellable

Opportunities/ Untapped Potentials:

 The subsidiary, on a 24-hour operations, has unutilized capacity
 There is a plan to reduce operating hours from 24 hours to 16 hours on weekdays and 8
hours on weekend.
 There are common cost such as payroll, billing, collections and accounting that are common
cost of the parent and the subsidiary which can be allocated prorate or per service use
between the parent and subsidiary company

III. Alternative Course of Actions

The company has basically 2 courses of actions they can execute in this case; continue
operations or shutdown/ close down the subsidiary and sell its assets.

Continue Operations
 The company before deciding to change to 2 shifts, should evaluate first the existing capacity
since there is a huge number of hours that are not being used to gain revenue

Revenue Hours January February March Total

Total hours of revenue 361 348 401 1110
Available hours/ unutilized 175 188 167 530

Total hours of revenue 361 348 401

Available hours/ unutilized 175 188 167

Shutdown
The parent has also the option to shut down the operations of the subsidiary, however, there
will still be fixed costs that needs to be paid despite no operations.

On the table or computation shown below, we used the numbers coming from the latest month
of March as a basis for comparison for the alternative courses of action.

Also, the “continue operation” action assumed that the company would be able to utilize the
excess hours instead of reducing the number of hours of operations.
 Continue
Original operations Shutdown
Revenues:
Intercompany sales (205hours) 82,000 82,000
Commercial sales (using March data)
Rate $ 800 $ 800
No. of hours 138 305
Total Commercial revenue 110,400 244,000

Total Revenue 192,400 326,000 -

Variable Cost
Average rate from Question 2 $ 172 $ 172
No. of hours 343 510
Total Variable Cost 58,996 87,720 -

Contribution Margin 133,404 238,280 -

Fixed Cost:
Rent 8,000 8,000
Custodial services 1,240 1,240
Computer leases 95,000 95,000 95,000
Maintenance 5,400 5,400 5,400
Depreciation:
Computer equipment 25,500 25,500 25,500
Offi ce Equipment and fixtures 680 680 680
Systems development and maintenance 12,000 12,000
Administration 9,000 9,000
Sales 11,200 11,200
Total Fixed Cost 168,020 168,020 126,580

Net Income (loss) (34,616) 70,260 (126,580)

The results of analysis above show a huge difference in terms of net income or loss.

IV. Answers to Case Questions

1. Appraise the results of operations of Prestige Data Services. Is the subsidiary really a
problem to Prestige Telephone Company? Consider carefully the differences between
reported costs and costs relevant for decisions that Daniel Rowe is considering.

Looking at the original computation of the company (refer to Exhibit 2), one can conclude
right away that the company is at a loss. However, there are other means of more
 meaningful analysis that the company can use. One example would be the contribution
margin approach where cost are segregated into variable and fixed cost as shown below:

Revenues: January February March

Intercompany sales ($400/HR.) 82,000 72,400 82,000
Commercial sales ($800/HR.)
Computer use 98,400 108,000 110,400
Other 9,241 9,184 12,685
Total Revenue 189,641 189,584 205,085

Variable Cost:
Power 1,633 1,592 1,803
Operations 29,496 29,184 30,264
Materials 9,031 8,731 10,317
Sales promotions 7,909 7,039 8,083
Corporate services 15,424 15,359 15,236
63,493 61,905 65,703

Contribution Margin 126,148 127,679 139,382

Percentage 66.52% 67.35% 67.96%
Per hour 349.44 366.89 347.59

Fixed Cost:
Rent 8,000 8,000 8,000
Custodial services 1,240 1,240 1,240
Computer leases 95,000 95,000 95,000
Maintenance 5,400 5,400 5,400
Depreciation:
Computer equipment 25,500 25,500 25,500
Offi ce Equipment and fixtures 680 680 680
Systems development and maintenance 12,000 12,000 12,000
Administration 9,000 9,000 9,000
Sales 11,200 11,200 11,200
168,020 168,020 168,020

Net Income (loss) (41,872) (40,341) (28,638)

Additional loss to the Company (400) - (7,200)

Net Income (loss) (42,272) (40,341) (35,838)

Taking into consideration the limitation, January & March intercompany sales were only
limited to the amount as prescribed by the Public Service Commission amounting to
$82,000.

Thus, the initial losses sustained by the company increased further by $400 in January and
$7,200 for March since there is an additional loss by the limitation imposed by the
commission on intercompany sales.
 Since the losses are further increased, one should not conclude right away to shutdown the
company. However further analysis on this on the Alternative Courses of Action Section
would prove otherwise.

2. Assuming the company demand for service will average 205 hours per month, what level of
commercial sales of computer use would be necessary to breakeven each month?
Revenues:
Commercial sales ($800/HR.) 800

Variable Cost:
Power 5,028
Operations 88,944
Materials 28,079
Sales promotions 23,031
Corporate services 46,019
Total 191,101
Divided by total hours 1,110
Variable cost per hour 172

Contribution Margin 628

Fixed Cost:
Rent 8,000
Custodial services 1,240
Computer leases 95,000
Maintenance 5,400
Depreciation:
Computer equipment 25,500
Offi ce Equipment and fixtures 680
Systems development and maintenance 12,000
Administration 9,000
Sales 11,200
168,020

Breakeven:
168,020
78.48%

Sales (in dollars) 214,093.81

168,020
628

Sales (in hours) 268

 As shown above computation, the company will breakeven at 268 hours or at $214,093.81
dollar sales for its commercial operations. Total fixed cost of $168,020 was used as a basis of
computation to determine the level of breakeven sales. Breakeven would allow the
company to see the point where sales would equal costs. This would assist the company in
coming up with strategy to exceed breakeven in order to gain income.

If demand was at 205, the company needs to exert additional effort to gain additional 63
more hours to reach its target breakeven sales. Furthermore, the company should target a
higher additional hours if it wants to earn higher income.

3. Estimate the effect on income of each of the options Rowe has suggested if Bradley
estimates as follows:

In answering these questions, we used the data on the latest month which is March. The
analysis on this was concentrated on the commercial hours since the intercompany is
already fixed at $82,000.

Original 3a 3b 3c 3d
Revenues:
Intercompany sales (205hours) 82,000 82,000 82,000 82,000 82,000
Commercial sales (using March data)
Rate $ 800 1,000 600 800 800
No. of hours 138 97 179 179 110
Total Commercial revenue 110,400 96,600 107,640 143,520 88,320

Total Revenue 192,400 178,600 189,640 225,520 170,320

Variable Cost
Average rate from Question 2 $ 172 $ 172 $ 172 $ 172 $ 172
No. of hours 343 302 384 384 315
Total Variable Cost 58,996 51,944 66,048 66,048 54,180

Contribution Margin 133,404 126,656 123,592 159,472 116,140

Fixed Cost:
Rent 8,000 8,000 8,000 8,000 8,000
Custodial services 1,240 1,240 1,240 1,240 1,240
Computer leases 95,000 95,000 95,000 95,000 95,000
Maintenance 5,400 5,400 5,400 5,400 5,400
Depreciation:
Computer equipment 25,500 25,500 25,500 25,500 25,500
Offi ce Equipment and fixtures 680 680 680 680 680
Systems development and maintenance 12,000 12,000 12,000 12,000 12,000
Administration 9,000 9,000 9,000 9,000 9,000
Sales 11,200 11,200 11,200 11,200 11,200
Total Fixed Cost 168,020 168,020 168,020 168,020 168,020

Net Income (loss) (34,616) (41,364) (44,428) (8,548) (51,880)

 In each of the assumptions above, one can see the different levels of income or loss the
company would realize should it decides to make changes to its current operations. Since
there is a regulatory commission, the subsidiary would definitely not be able to increase its
selling price which is pegged currently at $800 per hour.

Increasing the number of revenue hours or commercial hours would definitely increase the
total sales revenue even without increasing the selling price.

4. Can you suggest changes in the accounting and reporting system now used for operations of
Prestige Data Services which would result in more useful information for Rowe and Bradley?

In making decisions based on cost analysis, variable costs are the only costs that should be
considered when making decisions since fixed cost are considered as unavoidable cost. They
will be incurred regardless of the decision you make, whether the company operates or not,
fixed cost will still have to be incurred/ paid. Per analysis above, the company is earning per
contribution margin. However due to fixed cost the company has incurred losses for the 3
months presented.

V. Recommendation

After careful analysis of the subsidiary of Prestige Telephone Company, we have concluded that
the subsidiary is far better off if they continue operating rather than to shut down. We highly
recommend that after deciding to continue operations, the subsidiary should strategize on how
to better use the existing unutilized capacity in increasing sales revenue from commercial sales
rather than decreasing the number of shifts per day.

Using the existing unutilized capacity which is at 530 hours for the past 3 months, the company
will be able to increase sales revenue as per analysis of alternative courses of actions. Continuing
operations would also help the company avoid costs that are unavoidable yet no revenues are
being earned despite the costs being expended.

In closing, moving forward, the company should use the contribution margin method of
analysing costs to better analyse the operations of the company. This would show the fixed and
variable costs of the company and would aid better in making decisions especially if the
company is constantly earning losses.