Dropping a customer, activity-based costing, ethics. Jack Arnoldson is the management accountant for Valley Restaurant Supply (VRS). Bob Gardner, the VRS sales manager, and Jack are meeting to discuss the profitability of one of the customers, Franco’s Pizza. Jack hands Bob the following analysis of Franco’s activity during the last quarter, taken from Valley’s activity-based costing system:

Sales...........................$15,600

Cost of goods sold (all variable)..................9,350

Order processing (25 orders processed at $200 per order)........5,000

Delivery (2,500 miles driven at $0.50 per mile)............1,250

Rush orders (3 rush orders at $110 per rush order)..........330

Sales calls (3 sales calls at $100 per call)...............300

Profits...........................($ 630)

Bob looks at the report and remarks, “I’m glad to see all my hard work is paying off with Franco’s. Sales have gone up 10% over the previous quarter!”

Jack replies, “Increased sales are great, but I’m worried about Franco’s margin, Bob. We were showing a profit with Franco’s at the lower sales level, but now we’re showing a loss. Gross margin percentage this quarter was 40%, down five percentage points from the prior quarter. I’m afraid that corporate will push hard to drop them as a customer if things don’t turn around.”

“That’s crazy,” Bob responds. “A lot of that overhead for things like order processing, deliveries, and sales calls would just be allocated to other customers if we dropped Franco’s. This report makes it look like we’re losing money on Franco’s when we’re not. In any case, I am sure you can do something to make its profitability look closer to what we think it is. No one doubts that Franco is a very good customer.”

Required

1. Assume that Bob is partly correct in his assessment of the report. Upon further investigation, it is determined that 10% of the order processing costs and 20% of the delivery costs would not be avoidable if VRS were to drop Franco’s. Would VRS benefit from dropping Franco’s? Show your calculations.

2. Bob’s bonus is based on meeting sales targets. Based on the preceding information regarding gross margin percentage, what might Bob have done last quarter to meet his target and receive his bonus?

How might VRS revise its bonus system to address this?

3. Should Jack rework the numbers? How should he respond to Bob’s comments about making Franco look more profitable?