Question

Companywide and Segment Break-Even Analysis; Decision Making

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

1.NO

the segmented income statement should be prepared in contribution margin income statement format to get clear picture of variable and fixed expenses.

it helps in easy analyses of break even points and individual contribution margin of each statement.

2.

	commercial	residential
sales	250000	500000
cost of goods sold	140000	360000
variable selling expense	25000[250000*10%]	50000[500000*10%]
contribution margin	85000[250000-140000-25000]	90000[500000-360000-50000]
fixed expense	55000	38000
allocated common fixed expenses(difference)	24000[85000-55000-6000]	48000[90000-38000-4000]
income	6000	4000

hence allocated expenses are in ratio of 1:2 between commercial and residential

2a. commercial 24000 residential 48000

which is the sales ratio 1:2 [250000:500000]

hence sales is used to allocate common fixed expenses.

2b. sales

3.NO

common cost should not be allocated to segment on the basis of some random measures like sales.

department cannot be held responsible for the costs that are not under the department control(common cost).

also common fixed cost can make a profitable department looks like it is incurring loss or lesser profit than its actually contributing.

so i do not agree with intern's decision to allocate common cost to comemrcial and residential segment.

4.contribution margin income statement

	Total	commercial	residential
sales	750000	250000	500000
variable cost*	575000	165000	410000
contribution margin	175000	85000[250000-165000]	90000[500000-410000]
fixed expense**	165000	79000	86000
Net income	10000	6000	4000

*variable cost

cost of goods sold	140000	360000
variable selling expense	25000[250000*10%]	50000[500000*10%]
Total	165000	410000

**fixed expenses

		commercial	residential
	fixed expense	55000	38000
	allocated common fixed expenses(difference)	24000	48000
	total	79000	86000

5.break even point company wide

break even dollars = fixed cost total / contribution margin ratio

contribution margin ratio = contribution margin / sales

=175000/750000

=23.33%

break even sales = 165000/23.333%(rounding to 3 decimals)

=707153$

6.

	commercial	residential
sales	250000	500000
contribution margin	85000	90000
contribution margin ratio	34%[85000/250000]	18%[90000/500000]
fixed cost	79000	86000
break even dollars	232353$[79000/34%]	477778$[86000/18%]

7.

	Total	commercial	residential
sales	750000	250000	500000
less
cost of goods sold	500000	140000	360000
variable sales commission	37500[750000*5%]	12500[250000*5%	25000[500000*5%]
contribution margin	212500	97500	115000
fixed cost	210000	94000	116000
net income	2500	3500	(1000)

	commercial	residential
fixed expense	55000	38000
fixed salary	15000	30000
allocated common fixed expenses(difference)	24000	48000[
total	94000	116000

	commercial	residential
sales	340000	680000
contribution margin	142800	156400
contribution margin ratio	42%[142800/340000]	23%[156400/680000]
fixed cost	121500	135000
break even dollars	289286$[121500/42%]	586957$[135000/23%]