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alternative is to report sales revenue net of all such sales
price reductions. I don™t recommend this method. The better
approach is to report sales revenue at established list prices.
All sales price negatives should be recorded in sales revenue
contra accounts that are deducted from gross (list price) sales
Figure 17.1 illustrates the reporting sales price negatives to
managers. Seven different reductions from sales revenue are
shown in this figure. A business may not have all the sales
contra accounts shown, but three or four are not unusual. The
amounts of each contra account may not be as large as shown
(hopefully not).
In the external income statement of the business, only net
sales revenue ($8,303,000 in Figure 17.1) is reported, as a
general rule. For internal management control reporting,
however, gross (list price) sales revenue before all sales price
reductions should be reported to give managers the complete
range of information they need for controlling sales prices.
Sales price negatives should be accumulated in contra (deduc-
tion) accounts so that managers can monitor each one relative

Gross sales revenue, at list prices $10,000,000
Sales price negatives:
Sales price discounts”normal ($150,000)
Sales price discounts”special ($200,000)
Sales returns ($175,000)
Quantity discounts ($275,000)
Rebates ($650,000)
Coupons ($165,000)
Sales price allowances ($ 82,000) ($ 1,697,000)
Net sales revenue $ 8,303,000
FIGURE 17.1 Sales revenue negatives in a management control


to established sales pricing policies and so they can make
comparisons with previous periods and with the goals (or
budget) for the current period.

Inventory Shrinkage
Inventory shrinkage is a serious problem for many busi-
nesses, especially retailers. These inventory losses are due
to shoplifting by customers, employee theft, and short
counting from suppliers. Many businesses also suffer inven-
tory obsolescence, which means they end up with some prod-
ucts that cannot be sold or have to be sold below cost. When
this becomes apparent, inventory should be decreased by
write-down entries. The inventories asset account is
decreased and an expense account is increased.
Losses caused by damage to and deterioration of products
being held in inventory and inventory write-downs to recog-
nize product obsolescence should be separated from losses
due to theft and dishonesty”but sometimes the term inven-
tory shrinkage is used to include any type of inventory disap-
pearance and loss. Inventory shrinkage of 1.5 to 2.0 percent
of retail sales is not unusual.
Inventory loss due to theft is a particularly frustrating
expense. The business buys (or manufactures) products and
then holds them in inventory, which entails carrying costs,
only to have them stolen by customers or employees. On the
other hand, inventory shrinkage due to damage from handling
and storing products, product deterioration over time, and
product obsolescence is a normal and inescapable economic
risk of doing business.

Internal management control reports definitely should sepa-
rate inventory shrinkage expense and not include it in the
cost-of-goods-sold expense. Inventory shrinkage is virtually
never reported as a separate expense in external income
statements; it is combined with cost-of-goods-sold or some
other expense. However, managers need to keep a close watch
on inventory shrinkage, and they cannot do so if it is buried in
the larger cost-of-goods-sold expense.
Another reason for separating inventory shrinkage in man-
agement control reports is that this expense does not behave
the same way as cost-of-goods-sold expense. Cost-of-goods-


sold expense varies with sales volume. Inventory shrinkage
may include both a fixed amount that is more or less the same
regardless of sales volume and an amount that may vary with
sales volume.
Strong internal controls help minimize inventory shrinkage.
But even elaborate and expensive inventory controls do not
eliminate inventory shrinkage. Almost every business tolerates
some amount of inventory shrinkage. For instance, most busi-
nesses look the other way when it comes to minor employee
theft; they don™t encourage it, of course, but they don™t do any-
thing about it, either. Preventing all inventory theft would be
too costly or might offend innocent customers and hurt sales
volume. Would you shop in retail stores that carried out body
searches on all customers leaving the store? I doubt it. Many
retailers even hesitate to require customers to check bags
before entering their stores. On the other hand, closed-circuit
TV monitors are common in many stores. Retailers are con-
stantly trying to find controls that do not offend their cus-
tomers. As you know, product packages are often designed to
make it difficult to shoplift (e.g., oversized packages that are
difficult to conceal).
In internal management control reports, the negative fac-
tors just discussed should be set out in separate expense
accounts if they are relatively material or listed separately in a
supplementary schedule. Managers may have to specifically
instruct their accountants to isolate these expenses. In exter-
nal income statements, these costs are grouped in a larger
expense account (e.g., cost of goods sold, general and admin-
istrative expenses).

Sales Volume Negatives
Sales returns can be a problem, although this varies from
industry to industry quite a bit. Many retailers accept sales
returns without hesitation as part of their overall marketing
strategy. Customers may be refunded their money, or they
may exchange for a different product. On the other hand,
products such as new cars are seldom returned (even when

Sales returns definitely should be accumulated in a separate
sales contra account that is deducted from gross sales revenue


(see Figure 17.1 again). The total of sales returns is very
important control information. On the other hand, in external
income statements only the amount of net sales revenue (gross
sales revenue less sales returns and all other sales revenue
negatives) is reported.
Lost sales due to temporary stock-outs (zero inventory situ-
ations) are important for managers to know about. Such non-
sales are not recorded in the accounting system. No sales
transaction takes place, so there is nothing to record in the
sales revenue account. However, missed sales opportunities
should be captured and kept track of in some manner, and the
amount of these lost sales should be reported to managers
even though no sales actually took place. Managers need a
measure of how much additional contribution margin could
have been earned on these lost sales.
Customers may be willing to back-order products, or sales
may be made for future delivery when customers do not need
immediate delivery; these are called sales backlogs. Informa-
tion about sales backlogs should be reported to managers, but
not as sales revenue, of course. If a customer refuses to back-
order or will not wait for future delivery, the sale may be lost.
As a practical matter, it is difficult to keep track of lost sales.
The manager may have to rely on other sources of informa-
tion, such as complaints from customers and the company™s
sales force.

Key Sales Ratios
Many retailers keep an eye on measures such as sales revenue
per employee and sales revenue per square foot of retail
space. Most retailers have general rules ($300 to $400 sales
per square foot of retail space, $250,000 sales per employee,
etc.). These amounts vary widely from industry to industry.
Trade associations collect data from their members and pub-
lish industry averages. Retailers can compare their perform-
ances against local and regional competition and against
national averages. Hotels and motels carefully watch their
occupancy rates, which is an example of a useful ratio to
measure actual sales against capacity.
When sales ratios are lagging, the business probably has
too much capacity”too many employees, too much space, too


many machines, and so on. The obvious solution is to reduce
the fixed operating costs of the business. However, reducing
these fixed expenses is not easy, as you probably know.
Employees may have to be fired (or temporarily laid off ),
major assets may have to be sold, contracts may have to be
broken, and so on. Downsizing decisions are extremely diffi-
cult to make. For one thing, they are an admission of the
inability of the business to generate enough sales volume to
justify its fixed expenses. Nonetheless, part of the manager™s
job is to make these painful decisions.

The tendency is to put off the decision, to delay the tough
choices that have to be made. In an article in the Wall Street
Journal, the former CEO of Westinghouse observed that one of
the biggest failings of U.S. chief executives is one of procrasti-
nating”executives are reluctant to face up to making these
decisions at the earliest possible time.

In Closing
I would like to show you examples of management control
reports. But control reports are highly confidential; companies
are not willing to release them outside the business. In some
situations, control reports contain proprietary information that
a business is not willing to give out without payment (e.g., cus-
tomer lists). Management control reports are like income tax
returns in this regard”neither is open for public inspection.
However, you may be able to get your hands on one type of
management control report”those that are required in a
franchise contract between the franchisee and the parent
company that owns the franchise name. These contracts usu-
ally require that certain accounting reports be prepared and
sent to the home office of the company that operates the
chain. These reports are full of management control informa-
tion that is very interesting. Perhaps you could secure a blank
form of such an accounting control report.
Last, I should point out that management control reports
vary a great deal from business to business. Compare in your
mind, if you would, the following types of businesses”a gam-
bling casino, a grocery store, an auto manufacturer, an elec-
tric utility, a bank, a hotel, and an airline. Each type of
business is unique in the types of control information its


managers need. The preceding comments offer general obser-
vations and suggestions for management control reports with-
out going into the many details for particular industries.

Typically, two or more products share a common base of fixed
operating expenses. For instance, consider the sales of a
department store in one building. There are many building
occupancy expenses, including rent (or depreciation), utilities,
property taxes, fire and hazard insurance, and so on. All
products sold in the store benefit from the fixed expenses. Or
consider a sales territory managed by a sales manager whose
salary and other office costs cover all the products sold in the
territory. Should such fixed expenses be allocated among the
different products?
Allocation may appear to be logical. The more basic question
is whether or not allocation really helps management decision
making and control. Allocation is a controversial issue, espe-
cially where product lines (or other product groupings) are
organized as separate profit centers for which different man-
agers have profit responsibility (and whose compensation may
depend, in part at least, on the profit performance of the orga-
nizational unit).
If a company sold only one product, there would be no cost
allocation problems between products”although there may
be common costs extending over two or more separate sales
regions (territories). The main concern in the following discus-
sion is the allocation of fixed expenses among products.

Sales Mix Analysis
Suppose you™re the general manager of a business™s major
division, which is one of the several autonomous profit cen-
ters in the organization. (I treat this as a profit module in the
following discussion.) Your division sells one basic product
line consisting of four products sold under the company™s


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