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14-39 Customer profitability and ethics. KC Corporation manufactures an air-freshening device called GoodAir, which it sells to six merchandising firms. The list price of a GoodAir is $30, and the full manufacturing costs are $18. Salespeople receive a commission on sales, but the commission is based on number of orders taken, not on sales revenue generated or number of units sold. Salespeople receive a commission of $10 per order (in addition to regular salary) KC Corporation makes products based on anticipated demand. KC carries an inventory of GoodAir, so rush orders do not result in any extra manufacturing costs over and above the $18 per unit. KC ships finished product to the customer at no additional charge for either regular or expedited delivery. KC incurs significantly higher costs for expedited deliveries than for regular deliveries. Customers occasionally return shipments to KC, and the company subtracts these returns from gross revenue. The customers are not charged a restocking fee for returns. Budgeted (expected) customer-level cost driver rates are Order taking (excluding sales commission) Product handling Delivery Expedited (rush) delivery Restocking $15 per order 1 per unit $1.20 per mile driven $175 per shipment $50 per returned shipment $125 per customer Visits to customers Because salespeople are paid $10 per order, they often break up large orders into multiple smaller orders. This practice reduces the actual order-taking cost by S7 per smaller order (from $15 per order to S8 per order) because the smaller orders are all written at the same time. This lower cost rate is not included in budgeted rates because salespeople create smaller orders without telling management or the accounting department. All other actual costs are the same as budgeted costs.Explanation / Answer
1.
2. Customer-level operating income based on expected cost of orders:
3.
The answers for 2 and 3 shows that operating income is higher than expected. Thus the management of the company will be satisfied with the salespeople's performance towards cost reduction. Leaving aside DC all other customers are more profitable than the amount that was reported originally.
4.
5.
We can see that the behavior of the salespeople is leading to fall of $588 in profits. Management is under the impression that salespeople are saving money. However the reality is quite different as the salespeople are actually costing money as they are causing the cost of orders to increase. The cost was $1028 in 3 and $930 in 4. The salespeople are also increasing the amount of commissions earned by them. It was $1110 in 3 and $620 in 4. This is clearly not an ethical behavior.
To change the behavior of its salespeople the company needs to change the structure of the current sales commission. The commissions should be linked to the number of units and not number of orders.
Order taking Customer batch level Product handling Customer output unit level Delivery Customer batch level Expedited delivery Customer batch level Restocking Customer batch level Visits to customers Customer sustaining level Sales commission Customer batch levelRelated Questions
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