Question

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	$	945,000		$	315,000		$	630,000
Cost of goods sold		630,000			170,100			459,900
Gross margin		315,000			144,900			170,100
Selling and administrative expenses		292,000			130,000			162,000
Net operating income	$	23,000		$	14,900		$	8,100

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 $67,500 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $76,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $54,000 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 $24,000 and $48,000, 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

Answer 2

Solution

1.No, do not agree with the intern’s decision to use an absorption format for her segmented income statement
2.a.
Allocation of common expenses is as follows
	Residential	Comercial
Selling and Admin Expenses	162,000	130,000
Less: Sales Commission	63,000	31,500
Less: Traceable fixed expenses	54,000	76,000
Common Expenses Allocated	45,000	22,500
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
	Commercial	Residential
Sales	315,000	630,000
Less: Variable Expenses
Cost of Goods Sold	170,100	459,900
Selling and Admin Expenses	31,500	63,000
Contribution Margin	113,400	107,100
Less: Traceable Fixed Expenses	76,000	54,000
Segment Margin	37,400	53,100
Less: Common Fixed Expenses
Net Operating Income
5.Contribution Margin Ratio = Contribution Margin/Sales
=220,500/945000
23.33%
Break even point = Fixed costs/CM Ratio
846,550 (67500+130,000)/23.33%
6. Commercial Division = 113,400/315,000 = 36% 76,000/36% = $2,11,111.11
Residential = 107,100/630,000 = 17% 54,000/17% = $317,647.06
	Commercial	Residential
Sales	315,000	630,000
Less: Variable Expenses
Cost of Goods Sold	170,100	459,900
Selling and Admin Expenses	15,750	31,500
Contribution Margin	129,150	138,600
Less: Traceable Fixed Expenses	100,000 (76000+24000)	102,000 (54,000+48,000)
Segment Margin	29,150	36,600
7.Commercial = 129,150/315,000 = 41% (76,000+24000)/41% = $243,902.40
Residential = 138,600/630,000 = 22% (54,000+48,000)/22% = $463,636.40