I don’t get it. We ran the numbers, and it all looked pretty good. Then we exceeded our sales projections, which should make things better. Yet the accountants tell us we’re losing money. It just doesn’t compute!

The speaker was Antonio García, manager of the Portable Communication Device (PCD) division of Casa Electrónica, S.A. (CESA), a a large retail electronic store located in downtown Buenos Aires, Argentina. He was discussing the poor financial performance of a new line of electronic pagers that the store had begun selling a month earlier. He continued:

We ran a CVP [cost-volume-profit) analysis on the pagers, and convinced senior management that it made sense to move ahead with them. Unless I can figure out what’s going on and find a way to explain it all, my head’s going to be on the block at next week’s meeting.

BACKGROUND

CESA imported large appliances and distributed them to retailers throughout Argentina. It carried three broad lines of merchandise: audio equipment (such as stereo tuners, CD players, and radios), video equipment (including televisions and VCRs), and portable communication devices (such as cell phones).

Following a business trip to Europe in which he had seen widespread use of pagers, and under pressure to improve his division’s profits, Sr. García had decided to explore the idea of adding pagers to the PCD division’s offerings. He commented on the analysis that his staff had made:

The numbers are pretty simple. The pagers sell for $100. They cost us $40 each, which includes all insurance and freight charges to get them to the store. When we looked at the extra work involved in the warehouse, we found that we had to add some more employees, who cost us $10,000 a month including fringes.
Our analysis even included the cost of some additional clerical staff. We figured that the extra paperwork would mean another 1/2 FTE [full-time equivalent] in the administrative offices, which translated into $2,000 a month including fringes. We knew we could sell at least 250 pagers a month with no extra advertising, and, based on that, we convinced corporate that the pagers were a good bet.

DATA

In the first month, CESA sold 300 pagers. However, much to Sr. García’s surprise, the accountants’ Product-Line Report, shown in Exhibit 1, reported a $4,000 loss. It was this that led to his comment at the beginning of the case. In his view,

This is idiocy! We did what we said we would do. The company hired some additional warehouse personnel whose salaries and fringes total $10,000, and the admin folks hired a new person, who divides his work about 50/50 between our division and the video division. Our fair share should be $2,000, just as we had projected. Yet both warehouse and admin are much bigger than this.
I asked the accountants what was going on, and they told me that this [Exhibit 1] is their standard approach to computing product line profitability. So what do I do now?

Assignment

1. Using Sr. García’s assumptions, what was the estimated breakeven volume for the pagers? Based on his sales projections, how much before-tax profit did Sr. García expect the pagers to earn for the company?
2. Assuming that all of Sr. García’s price and cost figures were correct, how much should the company have earned before taxes from pager sales in the first month? How would you reconcile this figure with the accountants’ analysis in Exhibit 1?
3. What should Sr. García do?