*Local administrative expenses are the administrative expenses incurred at the check processing centers. ↑Regional administrative expenses are allocated to the check processing centers based on sales. ↑Corporate administrative expenses are charged to segments of the company such as the Rocky Mountain Region and the check processing centers at the rate of 9.5% of their sales. Upon seeing this report, Ms. Romeros summoned John Littlebear for an explanation. Romeros:
What’s the story on Clayton? It didn’t have a loss the previous year did it?
No, the Clayton facility has had a nice profit every year since it was opened six years ago, but Clayton lost a big contract this year. Romeros:
One of our national competitors entered the local market and bid very aggressively on the contract. We couldn’t afford to meet the bid. Clayton’s costs—particularly their facility expenses—are just too high. When Clayton lost the contract, we had to lay off a lot of employees, but we could not reduce the fixed costs of the Clayton facility. Rameros:
Why is Clayton’s facility expense so high? It’s a smaller facility than either Billings or Great Falls and yet its facility expense is higher. Littlebear:
The problem is that we are able to rent suitable facilities very cheaply at Billings and Great Falls. No such facilities were available at Clayton; we had them built. Unfortunately, there were big cost overruns, The contractor we hired was inexperienced at this kind of work and in fact went bankrupt before the project was completed. After hiring another contractor to finish the work, we were way over budget. The large depreciation charges on the facility didn’t matter at first because we didn’t have much competition at the time and could charge premium prices. Rorneros:
Well we can’t do that anymore. The Clayton facility will obviously have to be shut down. Its business can be shifted to the other two check processing centers in the region. Littlebear:
I would advise against that. The $1,200,000 in depreciation at the Clayton facility is misleading. That facility should last indefinitely with proper maintenance. And it has no resale value; there is no other commercial activity around Clayton. Romeros:
What about the other costs at Clayton?
If we shifted Clayton’s business over to the other two processing centers in the region, we wouldn’t save anything on direct labor or variable overhead costs. We might save $90,000 or so in local administrative expense, but we would not save any regional administrative expense and corporate headquarters would still charge us 9.5% of our sales as corporate administrative expense. In addition, we would have to rent more space in Billings and Great Falls in order to handle the work transferred from Clayton; that would...