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	$	750,000		$	250,000		$	500,000
Cost of goods sold		500,000			140,000			360,000
Gross margin		250,000			110,000			140,000
Selling and administrative expenses		240,000			104,000			136,000
Net operating income	$	10,000		$	6,000		$	4,000

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 $72,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $55,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $38,000 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 $15,000 and $30,000, 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	104000	136000
Less: Direct fixed expesnes	55000	38000
Less: variable Sales Commission (10% of sales)	25000	50000
Common Fixed expesnes allocated to Segments	24000	48000
Solution 2b:
	Commercial	Residential	Total
Total Sales	250000	500000	750000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	24000	48000	72000
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	750000	250000	500000
Variable expenses:
Cost of goods sold	500000	140000	360000
Sales commissions	75000	25000	50000
Total Variable expenses	575000	165000	410000
Contribution margin	175000	85000	90000
Less: Direct Fixed Expesnes	93000	55000	38000
Segment Margin	82000	30000	52000
Less: Common fixed expenses	72000
Net Operating Income	10000
Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	175000
/Total Sales	750000
Contribution Margin ratio	23.333%
Total Companywide Fixed Costs (86000+84000)	165000
/Contribution Margin ratio	23.333%
Companywide Break even point in dollar sales	707144
Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	85000	90000
/Segment's Sales	250000	500000
Contribution Margin ratio	34.00%	18.00%
Direct Fixed Costs	55000	38000
/Contribution Margin ratio	34.00%	18.00%
Segment's Break even point in dollar sales	161765	211111
Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	250000	500000
Variable expenses:
Cost of goods sold	140000	360000
revised Sales commissions	12500	25000
Total Variable expenses	152500	385000
Contribution margin	97500	115000
Revised Contribution Margin ratio	39.00%	23.00%
Revised Direct Fixed Expesnes	70000	68000
/Contribution Margin ratio	39.00%	23.00%
Segment's Break even point in dollar sales	179487	295652