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 $ 810,000 $ 270,000 $ 540,000 Cost of goods sold 548,100 153,900 394,200 Gross margin 261,900 116,100 145,800 Selling and administrative expenses 256,000 112,000 144,000 Net operating income $ 5,900 $ 4,100 $ 1,800 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 $81,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $58,000 of fixed expenses that would be avoided if the Commericial segment is dropped, and $36,000 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

1. No. I don't agree with using absorption costing faroamt income statement. This is because there will be some expenses which are directly related to the segments and some others which donot directly relate to them. By combining all the costs the segemntwise profitability will not give a true picture.We can check from the two tables given below.

2. a.

		Commercial	Residential
Selling and administrative expenses		112000	144000
Sales commissions (10%)		27000	54000
Fixed costs		85000	90000
Fixed costs than can be avoided		58000	36000
Common fixed expenses allocated		27000	54000

2.b.

She has used sales as the basis for allocating the common fixed expenses. These have been allocated @10% of sales value.

3.

No. The common fixed expenses allocation to segements will give a wrong picture of the profitability of the segments which may result in wrong decision making.

4.

	Total	Commercial	Residential
Sales	810000	270000	540000
Variable costs:
Cost of goods sold	548100	153900	394200
Sales commission	81000	27000	54000
Total variable costs	629100	180900	448200
Segment Contribution margin	180900	89100	91800
Segment fixed costs	94000	58000	36000
Segment net operating income	86900	31100	55800
Common fixed costs	81000
Net operting income	5900

5.

Companywide breakeven point = Fixed costs / Contribution margin =(94,000 + 81,000) / 22.33% *

= 175,000 / 22.33% = $783,699

* Contribution margin = Contribution margin / Sales = 180,900 / 810,000 = 22.33%

6.

		Commercial	Residential
Break - even point = Fixed costs / Contribution margin		=58000/33%	=36000/17%
		175758	211765
Contribution margin = Contribution in $ / Sales in $		=89100/270000	=91800/540000
		33.00%	17.00%

7.

	Total	Commercial	Residential
Sales	810000	270000	540000
Variable costs:
Cost of goods sold	548100	153900	394200
Sales commission (5%)	40500	13500	27000
Total variable costs	588600	167400	421200
Segment Contribution margin	221400	102600	118800
Sales salaries	45000	15000	30000
Avoidable fixed costs	94000	58000	36000
Total segment fixed costs	139000	73000	66000
Segment net operating income	82400	29600	52800
Common fixed costs	81000
Net operting income	1400

		Commercial	Residential
Break - even point = Fixed costs / Contribution margin		=73000/38%	=66000/22%
		192105	300000
Contribution margin = Contribution in $ / Sales in $		=102600/270000	=118800/540000
		38.00%	22.00%