Salem Telephone Company

Salem Telephone Company

Salem Telephone Company (STC) is faced with the decision of whether or not they will continue operations of Salem Data Services (SDS). In order for management to make an informed decision, they must look further into the detailed accounting aspects of both STC and SDS.

In preparation for determining the possible effects on profits of increasing the price to customers other than STC, reducing prices, and increasing efforts, the following 6 questions must be answered:

1. “Revenue hours” represent the key activity that drives costs at Salem Data Services. Which expenses in exhibit 2 are variable with respect to revenue hours? Which Expenses are fixed with respect to revenue hours?

2. For each expense that is variable with respect to revenue hours, calculate the cost per revenue hour.

3. Create a contribution margin income statement for Salem Data Services. Assume that the intra-company usage is 205 hrs. Assume commercial usage is the March level.

4. Assuming the intercompany 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 options Flores has suggested if Wu Estimates as follows:

6. Based on your analysis above, is Salem Data Services really a problem to Salem Telephone Company? What should Flores do about Salem Data Services?

First, we must divide the various costs incurred in SDS into two types: variable costs and fixed costs. From Exhibit 2 we can see that only “Power” and “Operations: hourly personnel” are variable costs that have relation to the total revenue hours. Other expenses listed in Exhibit 2 are all fixed costs.

Variable costs = Power & Operations; hourly personnel

Fixed costs = All other costs listed in Exhibit 2. We are considering Sales Promotion and Corporate services to be discretionary fixed costs.

See charter below

Since the...