Dropping a customer, activity-based costing, ethics. Justin Anders is the management accountant for Carey Restaurant Supply (CRS). Sara Brinkley, the CRS sales manager, and Justin are meeting to discuss the profitability of one of the customers, Donnelly’s Pizza. Justin hands Sara the following analysis of Donnelly’s activity during the last quarter, taken from CRS’s activity-based costing system:
Sara looks at the report and remarks, “I’m glad to see all my hard work is paying off with Donnelly’s. Sales have gone up 10% over the previous quarter!” Justin replies, “Increased sales are great, but I’m worried about Donnelly’s margin, Sara. We were showing a profit with Donnelly’s at the lower sales level, but now we’re showing a loss. Gross margin percentage this quarter was 40%, down five percentage points from the prior quarter. I’m afraid that corporate will push hard to drop them as a customer if things don’t turn around.” “That’s crazy,” Sara responds. “A lot of that overhead for things like order processing, deliveries, and sales calls would just be allocated to other customers if we dropped Donnelly’s. This report makes it look like we’re losing money on Donnelly’s when we’re not. In any case, I am sure you can do something to make its profitability look closer to what we think it is. No one doubts that Donnelly’s is a very good customer.”
1. Assume that Sara is partly correct in her assessment of the report. Upon further investigation, it is determined that 10% of the order processing costs and 20% of the delivery costs would not be avoidable if CRS were to drop Donnelly’s. Would CRS benefit from dropping Donnelly’s? Show your calculations.
2. Sara’s bonus is based on meeting sales targets. Based on the preceding information regarding gross margin percentage, what might Sara have done last quarter to meet her target and receive her bonus? How might CRS revise its bonus system to address this?
3. Should Justin rework the numbers? How should he respond to Sara’s comments about making Donnelly’s look more profitable?
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