Cathy's Classic Clothes is a retailer that sells to professional women in the northeast. The firm leases space for stores in upscale shopping centers, and the organizational structure consists of regions, districts, and stores. Each region consists of two or more districts; each district consists of three or more stores. Each store, district, and region has been established as a profit center. At all levels, the company uses a responsibility-accounting system focusing on information and knowledge rather than blame and control. Each year, managers, in consultation with their supervisors, establish financial and nonfinancial goals, and these goals are integrated into the budget. Actual performance is measured each month.

The New England Region consists of the Coastal District and the Inland District. The Coastal District includes the New Haven, Boston, and Portland stores. The Coastal District's performance has not been up to expectations in the past. For the month of May, the district manager has set performance goals with the managers of the New Haven and Boston stores, who will receive bonuses if certain performance measures are exceeded. The manager in Portland decided not to participate in the bonus scheme. Since the district manager is unsure what type of bonus will encourage better performance, the New Haven manager will receive a bonus based on sales in excess of budgeted sales of $570,000\$ 570,000, while the Boston manager will receive a bonus based on net income in excess of budgeted net income. The company's net income goal for each store is 1212 percent of sales. The budgeted sales revenue for the Boston store is $530,000\$ 530,000.

Other pertinent data for May are as follows:

  • Coastal District sales revenue was $1,500,000\$ 1,500,000, and its cost of goods sold amounted to $633,750\$ 633,750.

  • The Coastal District spent $75,000\$ 75,000 on advertising.

  • General and administrative expenses for the Coastal District amounted to $180,000\$ 180,000.

  • At the New Haven store, sales were 4040 percent of Coastal District sales, while sales at the Boston store were 3535 percent of district sales. The cost of goods sold in both New Haven and Boston was 4242 percent of sales.

  • Variable selling expenses (sales commissions) were 66 percent of sales for all stores, districts, and regions.

  • Variable administrative expenses were 2.52.5 percent of sales for all stores, districts, and regions.

  • Maintenance cost includes janitorial and repair services and is a direct cost for each store. The store manager has complete control over this outlay. Maintenance costs were incurred as follows: New Haven, $7,500\$7,500; Boston, $600\$600; and Portland, $4,500\$4,500.

  • Advertising is considered a direct cost for each store and is completely under the control of the store manager. The New Haven store spent two-thirds of the Coastal District total outlay for advertising, which was 1010 times the amount spent in Boston on advertising.

  • Coastal District rental expense amounted to $150,000\$ 150,000.

  • The rental expenses at the New Haven store were 4040 percent of the Coastal District's total, while the Boston store incurred 3030 percent of the district total.

  • District expenses were allocated to the stores based on sales.

  • New England Region general and administrative expenses of $165,000\$ 165,000 were allocated to the Coastal District. These expenses were, in turn, allocated equally to the district's three stores.

1.1. Prepare the May segmented income statement for the Coastal District and for the New Haven and Boston stores.

2.2. Compute the Portland store's net income for May.

3.3. Discuss the impact of the responsibility-accounting system and bonus structure on the managers' behavior and the effect of their behavior on the financial results for the New Haven store and the Boston store.

4.4. The assistant controller for the New England Region, Jack Isner, has been a close friend of the New Haven store manager for over 2020 years. When Isner saw the segmented income statement [as prepared in requirement (1)(1)], he realized that the New Haven store manager had really gone overboard on advertising expenditures. To make his friend look better to the regional management, he reclassified $25,000\$ 25,000 of the advertising expenditures as miscellaneous expenses, and buried them in rent and other costs. Comment on the ethical issues in the assistant controller's actions.


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Laser News Technology, Inc. manufactures computerized laser printing equipment used by newspaper publishers throughout North America. In recent years, the company's market share has been eroded by stiff competition from Asian and European competitors. Price and product quality are the two key areas in which companies compete in this market.

Ben McDonough, Laser News Technology's president, decided to devote more resources to the improvement of product quality after learning that his company's products had been ranked fourth in product quality in a recent survey of newspaper publishers. He believed that the company could no longer afford to ignore the importance of product quality. McDonough set up a task force that he headed to implement a formal quality-improvement program. Included on the task force were representatives from engineering, sales, customer service, production, and accounting, as McDonough believed this was a companywide program and all employees should share the responsibility for its success.

After the first meeting of the task force, Sheila Hayes, manager of sales, asked Tony Reese, the production manager, what he thought of the proposed program. Reese replied, "I have reservations. Quality is too abstract to be attaching costs to it and then to be holding you and me responsible for cost improvements. I like to work with goals that I can see and count! I don't like my annual income to be based on a decrease in quality costs; there are too many variables that we have no control over!"

Laser News Technology's quality-improvement program has now been in operation for 1818 months, and the following quality cost report has recently been issued. As they were reviewing the report, Hayes asked Reese what he thought of the quality program now. "The work is really moving through the Production Department," replied Reese. "We used to spend time helping the Customer Service Department solve their problems, but they are leaving us alone these days. I have no complaints so far. I'll be anxious to see how much the program increases our bonuses."

 LASER NEWS TECHNOLOGY, INC.  Cost of Quality Report  (in thousands) \begin{gathered} \textbf{ LASER NEWS TECHNOLOGY, INC. } \\ \textbf{ Cost of Quality Report } \\ \textbf{ (in thousands) } \end{gathered}

 Quarter Ended  6/30/x0  9/30/x0  12/31/x0  3/31/x1  6/30/x1  9/30/x1  Prevention costs:  Design review $20$102$111$100$104$95 Machine maintenance 215215202190170160 Training suppliers 54525202015 Total $240$362$338$310$294$270 Appraisal costs:  Incoming inspection $45$53$57$36$34$22 Final testing 16016015414011594 Total $205$213$211$176$149$116 Internal failure costs:  Rework $120$106$114$88$78$62 Scrap 686453424040 Total $188$170$167$130$118$102 External failure costs:  Warranty repairs $69$31$24$25$23$23 Customer returns 2622511221168780 Total $331$282$146$141$110$103 Total quality cost $964$1,027$862$757$671$591 Total production cost $4,120$4,540$4,380$4,650$4,580$4,510\begin{array}{lrrrrrr} &&& \textbf{ Quarter Ended } \\ \hline & \textbf{ 6/30/x0 } & \textbf{ 9/30/x0 } & \textbf{ 12/31/x0 } & \textbf{ 3/31/x1 } & \textbf{ 6/30/x1 } & \textbf{ 9/30/x1 } \\ \text{ Prevention costs: } & \\ \quad \text{ Design review } & \$ 20 & \$ 102 & \$ 111 & \$ 100 & \$ 104 & \$ 95 \\ \quad \text{ Machine maintenance } & 215 & 215 & 202 & 190 & 170 & 160 \\ \quad \text{ Training suppliers } & \underline{ 5 } & \underline{ 45 } & \underline{ 25 } & \underline{ 20 } & \underline{ 20 } & \underline{ 15 } \\ \quad \quad \text{ Total } & \underline{ \underline{ \$ 240 }} & \underline{ \underline{ \$ 362 }} & \underline{ \underline{ \$ 338 }} & \underline{ \underline{ \$ 310 }} & \underline{ \underline{ \$ 294 }} & \underline{ \underline{ \$ 270 }} \\ \text{ Appraisal costs: } & \\ \quad \text{ Incoming inspection } & \$ 45 & \$ 53 & \$ 57 & \$ 36 & \$ 34 & \$ 22 \\ \quad \text{ Final testing } & \underline{ 160 } & \underline{ 160 } & \underline{ 154 } & \underline{ 140 } & \underline{ 115 } & \underline{ 94 } \\ \quad \quad \text{ Total } & \underline{ \$ 205 } & \underline{ \$ 213 } & \underline{ \$ 211 } & \underline{ \$ 176 } & \underline{ \$ 149 } & \underline{ \$ 116 } \\ \text{ Internal failure costs: } & \\ \quad \text{ Rework } & \$ 120 & \$ 106 & \$ 114 & \$ 88 & \$ 78 & \$ 62 \\ \quad \text{ Scrap } & \underline{ 68 } & \underline{ 64 } & \underline{ 53 } & \underline{ 42 } & \underline{ 40 } & \underline{ 40 } \\ \quad \quad \text{ Total } & \underline{ \$ 188 } & \underline{ \$ 170 } & \underline{ \$ 167 } & \underline{ \$ 130 } & \underline{ \$ 118 } & \underline{ \$ 102 } \\ \text{ External failure costs: } & \\ \quad \text{ Warranty repairs } & \$ 69 & \$ 31 & \$ 24 & \$ 25 & \$ 23 & \$ 23 \\ \quad \text{ Customer returns } & \underline{ 262 } & \underline{ 251 } & \underline{ 122 } & \underline{ 116 } & \underline{ 87 } & \underline{ 80 } \\ \quad \quad \text{ Total } & \underline{ \$ 331 } & \underline{ \$ 282 } & \underline{ \$ 146 } & \underline{ \$ 141 } & \underline{ \$ 110 } & \underline{ \$ 103 } \\ \text{ Total quality cost } & \underline{ \underline{ \$ 964 }} & \underline{ \underline{ \$ 1,027 }} & \underline{ \underline{ \$ 862 }} & \underline{ \underline{ \$ 757 }} & \underline{ \underline{ \$ 671 }} & \underline{ \underline{ \$ 591 }} \\ \text{ Total production cost } & \underline{ \underline{ \$ 4,120 }} & \underline{ \underline{ \$ 4,540 }} & \underline{ \underline{ \$ 4,380 }} & \underline{ \underline{ \$ 4,650 }} & \underline{ \underline{ \$ 4,580 }} & \underline{ \underline{ \$ 4,510 }} \end{array}

1.1. Identify at least three factors that should be present for an organization to successfully implement a quality improvement program.

2.2. By analyzing the cost of quality report presented, determine if Laser News Technology's quality improvement program has been successful. List specific evidence to support your answer.

3.3. Discuss why Tony Reese's current reaction to the quality improvement program is more favorable than his initial reaction.

4.4. Laser News Technology's president believed that the quality improvement program was essential and that the firm could no longer afford to ignore the importance of product quality. Discuss how the company could measure the opportunity cost of not implementing the quality-improvement program.


Warriner Equipment Company, which is located in Ontario, Canada, manufactures heavy construction equipment. The company's primary product, an especially powerful bulldozer, is among the best produced in North America. The company operates in a very price-competitive industry, so it has little control over the price of its products. It must meet the market price. To do so, the firm has to keep production costs in check by operating as efficiently as possible. Mathew Basler, the company's president, has stated that, to be successful, the company must provide a very high-quality product and meet its delivery commitments to customers on time. Warriner Equipment Company is organized as shown below.

 Warriner Equipment Company  President and Chief Executive Officer \begin{array}{c} \textbf{ Warriner Equipment Company } \\ \text{ President and Chief Executive Officer } \end{array}

 Manufacturing Division  Sales Division  Vice President for Manufacturing  Vice President for Sales  10 Manufacturing Plants  5 Sales Districts \begin{array}{cc} \hline\text{ Manufacturing Division } & \text{ Sales Division } \\ \text{ Vice President for Manufacturing } & \text{ Vice President for Sales } \\ \hline\text{ 10 Manufacturing Plants } & \text{ 5 Sales Districts } \end{array}

There is currently a disagreement between the company's two vice presidents regarding the responsibility-accounting system. The vice president for manufacturing claims that the 1010 plants should be cost centers. He recently expressed the following sentiment: "The plants should be cost centers because the plant managers do not control the sales of our products. Designating the plants as profit centers would result in holding the plant managers responsible for something they can't control." A contrary view is held by the vice president for marketing. He recently made the following remarks: "The plants should be profit centers. The plant managers are in the best position to affect the company's overall profit."

As the company's new controller, you have been asked to make a recommendation to Mathew Basler, the company president, regarding the responsibility center issue. Write a memo to the president making a recommendation and explaining the reasoning behind it. In your memo, address the following points.

1.1. Assuming that Warriner Equipment Company's overall goal is profitability, what are the company's critical success factors? A critical success factor is a variable that meets these two criteria: It is largely under the company's control and the company must succeed in this area in order to reach its overall goal of profitability.

2.2. Which responsibility-accounting arrangement is most consistent with achieving success on the company's critical success factors?

3.3. What responsibility-center designation is most appropriate for the company's sales districts?

4.4. As a specific example, consider the rush-order problem illustrated in the chapter. Suppose that Warriner Equipment Company often experiences rush orders from its customers. Which of the two proposed responsibility-accounting arrangements is best suited to making good decisions about accepting or rejecting rush orders? Specifically, should the plants be cost centers or profit centers?