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	$	1,050,000		$	350,000		$	700,000
Cost of goods sold		682,500			178,500			504,000
Gross margin		367,500			171,500			196,000
Selling and administrative expenses		320,000			144,000			176,000
Net operating income	$	47,500		$	27,500		$	20,000

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 $57,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $90,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $68,000 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 $17,500 and $35,000, 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	144000	176000
Less: Direct fixed expesnes	90000	68000
Less: variable Sales Commission (10% of sales)	35000	70000
Common Fixed expesnes allocated to Segments	19000	38000
Solution 2b:
	Commercial	Residential	Total
Total Sales	350000	700000	1050000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	19000	38000	57000
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	1050000	350000	700000
Variable expenses:
Cost of goods sold	682500	178500	504000
Sales commissions	105000	35000	70000
Total Variable expenses	787500	213500	574000
Contribution margin	262500	136500	126000
Less: Direct Fixed Expesnes	158000	90000	68000
Segment Margin	104500	46500	58000
Less: Common fixed expenses	57000
Net Operating Income	47500
Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	262500
/Total Sales	1050000
Contribution Margin ratio	25.000%
Total Company wide Fixed Costs (158000+57000)	215000
/Contribution Margin ratio	25.000%
Companywide Break even point in dollar sales	860000
Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	136500	126000
/Segment's Sales	350000	700000
Contribution Margin ratio	39.00%	18.00%
Direct Fixed Costs	90000	68000
/Contribution Margin ratio	39.00%	18.00%
Segment's Break even point in dollar sales	230769	377778
Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	350000	700000
Variable expenses:
Cost of goods sold	178500	504000
revised Sales commissions	17500	35000
Total Variable expenses	196000	539000
Contribution margin	154000	161000
Revised Contribution Margin ratio	44.00%	23.00%
Revised Direct Fixed Expesnes	107500	103000
/Contribution Margin ratio	44.00%	23.00%
Segment's Break even point in dollar sales	244318	447826