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	$	960,000		$	320,000		$	640,000
Cost of goods sold		636,800			169,600			467,200
Gross margin		323,200			150,400			172,800
Selling and administrative expenses		296,000			132,000			164,000
Net operating income	$	27,200		$	18,400		$	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 $66,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $78,000 of fixed expenses that would disappear if the Commercial segment is dropped, and $56,000 of fixed expenses that would disappear 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 $25,000 and $50,000, 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

Solution 1:
No, the intern’s decision to use an absorption format for her segmented income statement is not a good idea because because if break even is to be calculated then contribution format should be used rather than absorption format.
Solution 2a:
	Commercial	Residential
Total Selling and administrative expenses	132000	164000
Less: Direct fixed expesnes	78000	56000
Less: variable Sales Commission (10% of sales)	32000	64000
Common Fixed expesnes allocated to Segments	22000	44000
Solution 2b:
	Commercial	Residential	Total
Total Sales	320000	640000	960000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	22000	44000	66000
Ratio	0.33	0.67
Hence, Allocation is based on Sales. Option "a = Sales" is correct.
Solution 3:
No, we don’t agree with the intern’s decision to allocate common fixed expesnes because theses expenses does not directly related to segments.
Solution 4:
Segmented Income Statement (Using contribution format)
	Total	Commercial	Residential
Sales	960000	320000	640000
Variable expenses:
Cost of goods sold	636800	169600	467200
Sales commissions	96000	32000	64000
Total Variable expenses	732800	201600	531200
Contribution margin	227200	118400	108800
Less: Direct Fixed Expesnes	134000	78000	56000
Segment Margin	93200	40400	52800
Less: Common fixed expenses	66000
Net Operating Income	27200
Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	227200
/Total Sales	960000
Contribution Margin ratio	23.667%
Total Company wide Fixed Costs (134000+66000)	200000
/Contribution Margin ratio	23.667%
Companywide Break even point in dollar sales	845069
Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	118400	108800
/Segment's Sales	320000	640000
Contribution Margin ratio	37.00%	17.00%
Direct Fixed Costs	78000	56000
/Contribution Margin ratio	37.00%	17.00%
Segment's Break even point in dollar sales	210811	329412
Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	320000	640000
Variable expenses:
Cost of goods sold	169600	467200
revised Sales commissions	16000	32000
Total Variable expenses	185600	499200
Contribution margin	134400	140800
Revised Contribution Margin ratio	42.00%	22.00%
Revised Direct Fixed Expesnes	103000	106000
/Contribution Margin ratio	42.00%	22.00%
Segment's Break even point in dollar sales	245238	481818