Randolph Company’s product mix has become more diverse over the past few years. Consequently the company undertook an activity-based costing initiative to develop accurate costs for production, as well as marketing, selling, distribution, and administration. The company set list prices that would provide a profit regardless of whether the customer orders were complex or routine. Nevertheless, profits have been falling. The company’s management team decided to examine discounts that had been granted to determine whether these are the reason for poor profit performance.

Management was surprised to learn that customers were taking advantage of a large number of possible discounts or allowances, including the following:

1. Volume discount if 20 or more units are ordered 2%

2. Pay in full in 15 days 3%

3. Cooperative advertising allowance for featuring the company’s products in its advertisements 4%

4. Take a large shipment before the end of the quarter in advance of an expected seasonal increase in demand 5%

5. Online ordering discount 2%

6. Rebate on sales during specific promotional periods 2%

The management team believed that some discounting was necessary to acquire and retain large customers. On deeper investigation, they learned that some of their smaller customers, who were often the most cost conscious, took advantage of every discount or allowance offered. To compare discounts or allowances taken, they compared Customer 1 and Customer 2.

Customer 1 is a long-time customer with sales of $200,000 at list prices. This customer takes advantage of each discount or allowance listed in the preceding table. Moreover, this customer has been a loyal customer since Randolph Company’s inception. In appreciation, Randolph’s sales representative offers free freight, which amounts to 3% of the customer’s list-price purchases from Randolph.

Customer 2 is a more recently acquired customer with sales of $1,000,000 at list prices. This customer only takes advantage of items 1, 3, and 5 in the preceding table.

Required

(a) Compute the total sales discount percentage for Customer 1 and for Customer 2.

(b) Why might Randolph Company’s management team have been unaware of the potentially large total discounts offered to its customers?

(c) What advice do you have for Randolph Company regarding managing its discounts and allowances?