Question

Problem 11-26 Close or Retain a Store [LO11-2]

Superior Markets, Inc., operates three stores in a large metropolitan area. A segmented absorption costing income statement for the company for the last quarter is given below:

Superior Markets, Inc. Income Statement For the Quarter Ended September 30
	Total			North Store			South Store			East Store
Sales	$	4,500,000		$	900,000		$	1,800,000		$	1,800,000
Cost of goods sold		2,475,000			550,000			935,000			990,000
Gross margin		2,025,000			350,000			865,000			810,000
Selling and administrative expenses:
Selling expenses		847,000			246,400			322,500			278,100
Administrative expenses		458,000			121,000			173,400			163,600
Total expenses		1,305,000			367,400			495,900			441,700
Net operating income (loss)	$	720,000		$	(17,400	)	$	369,100		$	368,300

The North Store has consistently shown losses over the past two years. For this reason, management is giving consideration to closing the store. The company has asked you to make a recommendation as to whether the store should be closed or kept open. The following additional information is available for your use:

1. The breakdown of the selling and administrative expenses that are shown above is as follows:

	Total		North Store		South Store		East Store
Selling expenses:
Sales salaries	$	237,000	$	63,800	$	71,000	$	102,200
Direct advertising		180,000		66,000		87,000		27,000
General advertising*		67,500		13,500		27,000		27,000
Store rent		300,000		84,000		117,000		99,000
Depreciation of store fixtures		23,500		6,100		7,500		9,900
Delivery salaries		25,500		8,500		8,500		8,500
Depreciation of delivery equipment		13,500		4,500		4,500		4,500
Total selling expenses	$	847,000	$	246,400	$	322,500	$	278,100

*Allocated on the basis of sales dollars.

	Total		North Store		South Store		East Store
Administrative expenses:
Store managers' salaries	$	92,500	$	28,500	$	37,500	$	26,500
General office salaries*		67,500		13,500		27,000		27,000
Insurance on fixtures and inventory		40,000		12,000		16,500		11,500
Utilities		82,125		27,355		25,800		28,970
Employment taxes		63,375		17,145		21,600		24,630
General office—other*		112,500		22,500		45,000		45,000
Total administrative expenses	$	458,000	$	121,000	$	173,400	$	163,600

*Allocated on the basis of sales dollars.

1. The lease on the building housing the North Store can be broken with no penalty.

2. The fixtures being used in the North Store would be transferred to the other two stores if the North Store were closed.

3. The general manager of the North Store would be retained and transferred to another position in the company if the North Store were closed. She would be filling a position that would otherwise be filled by hiring a new employee at a salary of $12,500 per quarter. The general manager of the North Store would continue to earn her normal salary of $13,500 per quarter. All other managers and employees in the North store would be discharged.

4. The company has one delivery crew that serves all three stores. One delivery person could be discharged if the North Store were closed. This person’s salary is $5,500 per quarter. The delivery equipment would be distributed to the other stores. The equipment does not wear out through use, but does eventually become obsolete.

5. The company pays employment taxes equal to 15% of their employees' salaries.

6. One-third of the insurance in the North Store is on the store’s fixtures.

7. The “General office salaries” and “General office—other” relate to the overall management of Superior Markets, Inc. If the North Store were closed, one person in the general office could be discharged because of the decrease in overall workload. This person’s compensation is $6,750 per quarter.

Required:

1. How much employee salaries will the company avoid if it closes the North Store?

2. How much employment taxes will the company avoid if it closes the North Store?

3. What is the financial advantage (disadvantage) of closing the North Store?

4. Assuming that the North Store's floor space can’t be subleased, would you recommend closing the North Store?

5. Assume that the North Store's floor space can’t be subleased. However, let's introduce three more assumptions. First, assume that if the North Store were closed, one-fourth of its sales would transfer to the East Store, due to strong customer loyalty to Superior Markets. Second, assume that the East Store has enough capacity to handle the increased sales that would arise from closing the North Store. Third, assume that the increased sales in the East Store would yield the same gross margin as a percentage of sales as present sales in the East store. Given these new assumptions, what is the financial advantage (disadvantage) of closing the North Store?

Answer 1

1. How much employee salaries will the company avoid if it closes the North Store?

Particulars	Amount
Sales salary (Relevant gain)	$63800
Delivery salary (Relevant gain)	$5500
Store management salary (Relevant gain) ($28500 - $14000)	$14500
Salary of new Manager (Relevant gain)	$13000
General Officer compensation (relevant gain)	$6750
Total salary avoided	$103550

2. How much employment taxes will the company avoid if it closes the North Store?

Part 2 Employment taxes avoided

Particulars	Amount
Total salary avoided	$103550
Employment tax rate	15%
Total employment tax avoided	$15532.5

3. What is the financial advantage (disadvantage) of closing the North Store?

Costs which are allocated are not avoidable since these costs fully absorbed.

Particulars	Amount
Relevant cost = Gross margin lost (A)	$350000
Less : Relevant gain (Costs avoided) (B)
Insurance ($12000 * 2/3)	$8000
Salary cost avoided	$103550
Employment tax avoided	$15532.5
Direct advertising	$66000
Store rent	$84000
Utilities	$27355
Net Disadvantage	$45562.5

As per analysis, North store should not be closed. If store is closed then income of company as a whole would be reduced by $45562.5

4. Assuming that the North Store's floor space can’t be subleased, would you recommend closing the North Store?

Part 4 - If office space cant not be subleased then rent cosr of north store could not be avoided and in such cases total effect on income would be ($45562.5 + $84000 = $129562.5)

hence Total income would be reduced by $129562.5

decision = Store should not be closed

Part -5 = Advantage/Disadvantage of closing north store if north store can't be subleased.

Particulars	Amount
Gross Margin lost from north store	$350000
Less : Gross margin gain from east store ($900000 * 1/4) * (810000/1800000 *100)	$101250
Net Operating loss in gross margin	$248750
Less : Costs avoided on closing north stors ($8000 + $103550 + $15532.5 + $66000 + $84000 + $27355)	$304437.5
Net advantage of closing the north store	$55687.5