Question

Keep or Drop a Division

Jan Shumard, president and general manager of Danbury Company, was concerned about the future of one of the company's largest divisions. The division's most recent quarterly income statement follows:

Sales		$3,751,500
Less:	Cost of goods sold	2,722,400
	Gross profit	$1,029,100
Less:	Selling and administrative expenses	1,100,000
	Operating (loss)	$ (70,900)

Jan is giving serious consideration to shutting down the division because this is the ninth consecutive quarter that it has shown a loss. To help him in his decision, the following additional information has been gathered:

The division produces one product at a selling price of $100 to outside parties. The division sells 50% of its output to another division within the company for $83 per unit (full manufacturing cost plus 25%). The internal price is set by company policy. If the division is shut down, the user division will buy the part externally for $100 per unit.

The fixed overhead assigned per unit is $20.

There is no alternative use for the facilities if shut down. The facilities and equipment will be sold and the proceeds invested to produce an annuity of $100,000 per year. Of the fixed selling and administrative expenses, 30% represent allocated expenses from corporate headquarters. Variable selling expenses are $5 per unit sold for units sold externally. These expenses are avoided for internal sales. No variable administrative expenses are incurred.

Required:

1. Prepare an income statement that more accurately reflects the division's profit performance. Round intermediate calculations to the nearest cent. Round final answers to the nearest dollar.

Answer 1

Calculations of units sold : Let units be x
$83* x/2 + 100* x/2 = $3751500
183x = 7503000
x = 41000 units

Manufacturing costs = $ 83 is manufacturing cost + 25%
83/1.25 = 66.40 = Manufacturing cost per unit
Fixed costs per unit = $20
Varaible costs = 66.40 - 20= 46.40
Variable selling cost = 5 per unit
Total variable cost = 46.40 + 5 =51.40 per unit
Total variabl cost amount = 20500 units * 51.40 + 20500 units * 46.40 = $2,004,900

Total selling and admin expenses = 1,100,000
Variable selling and admin expenses = 20500 * 5 = 102500
Fixed Selling and admin expenses = 1,100,000 - 102,500 = 997,500
Direct fixed selling and admin = 997500 * 70% =$ 698250
Direct fixed overhead = 41000 units * 20 = 820,000
Total direct fixed expenses =820,000 + 698,250 = $1,518,250
Common fixed expenses = 997500 * 30% = $ 299,250

Income Statement:
Sales                                           $3,751,500
Less: Variable Costs                    $2,004,900
Contribution                                  $1,746,600
Less: Fixed costs                         $1,518,250
Divisional Margin                           $228,350
Less: Common Fixed Expenses     $299250
Operating Loss                             $70,900