Question

Problem 6-24 Companywide and Segment Break-Even Analysis; Decision Making [LO6-4, LO6-5] Toxaway Company is a merchandiser that segments its business into two divisions—Commercial and Residential. The company’s accounting intern was asked to prepare segmented income statements that the company’s divisional managers could use to calculate their break-even points and make decisions. She took the prior month’s companywide income statement and prepared the absorption format segmented income statement shown below:

Total Company Commercial Residential Sales $ 840,000 $ 280,000 $ 560,000 Cost of goods sold 557,200 154,000 403,200 Gross margin 282,800 126,000 156,800 Selling and administrative expenses 264,000 116,000 148,000 Net operating income $ 18,800 $ 10,000 $ 8,800 In preparing these statements, the intern determined that Toxaway’s only variable selling and administrative expense is a 10% sales commission on all sales. The company’s total fixed expenses include $78,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $62,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $40,000 of fixed expenses that would be avoided if the Residential segment is dropped. Required: 1. Do you agree with the intern’s decision to use an absorption format for her segmented income statement? 2. Based on a review of the intern’s segmented income statement. a. How much of the company’s common fixed expenses did she allocate to the Commercial and Residential segments? b. Which of the following three allocation bases did she most likely used to allocate common fixed expenses to the Commercial and Residential segments: (a) sales, (b) cost of goods sold, or (c) gross margin? 3. Do you agree with the intern’s decision to allocate the common fixed expenses to the Commercial and Residential segments? 4. Redo the intern’s segmented income statement using the contribution format. 5. Compute the companywide break-even point in dollar sales. 6. Compute the break-even point in dollar sales for the Commercial Division and for the Residential Division. 7. Assume the company decided to pay its sales representatives in the Commercial and Residential Divisions a total monthly salary of $17,000 and $34,000, respectively, and to lower its companywide sales commission percentage from 10% to 5%. Calculate the new break-even point in dollar sales for the Commercial Division and the Residential Division.

Answer 1

1.No, do not agree
2.a.
Allocation of common expenses is as follows
	Commercial	Residential
Selling and Admin Expenses	116,000	148,000
Less: Sales Commission	28,000	56,000
Less: Traceable fixed expenses	62,000	40,000
Common Expenses Allocated	26,000	52,000
b.Sales, is used since expenses allocated in the ratio of 1:2
3.No, Since common expenses are unavoidable
4.Contribution Margin format Income Statement
	Total	Commercial	Residential
Sales	840,000	280,000	560,000
Less: Variable Expenses
Cost of Goods Sold	557,200	154,000	403,200
Selling and Admin Expenses	84,000	28,000	56,000
Contribution Margin	198,800	98,000	100,800
Less: Traceable Fixed Expenses	102,000	62,000	40,000
Segment Margin	96,800	36,000	60,800
Less: Common Fixed Expenses	78,000
Net Operating Income	18,800
5.Contribution Margin Ratio = Contribution Margin/Sales
=198800/840,000=23.67%
Break even point = Fixed costs/CM Ratio
=(102,000+18,800)/23.67% = $510,350.65
6. Commercial Division = 62,000/35% = $177,142.86
Residential = 40,000/18% = $222,222.22
7.Commercial = (62,000+17,000)/40% = $197,500
Residential = (40,000+34,000)/23% = $321,739.13