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	$	915,000		$	305,000		$	610,000
Cost of goods sold		585,600			152,500			433,100
Gross margin		329,400			152,500			176,900
Selling and administrative expenses		284,000			126,000			158,000
Net operating income	$	45,400		$	26,500		$	18,900

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 $70,500 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $72,000 of fixed expenses that would disappear if the Commercial segment is dropped, and $50,000 of fixed expenses that would disappear 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 $22,000 and $44,000, 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	126000	158000
Less: Direct fixed expesnes	72000	50000
Less: variable Sales Commission (10% of sales)	30500	61000
Common Fixed expesnes allocated to Segments	23500	47000

Solution 2b:
	Commercial	Residential	Total
Total Sales	305000	610000	915000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	23500	47000	70500
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	915000	305000	610000
Variable expenses:
Cost of goods sold	585600	152500	433100
Sales commissions	91500	30500	61000
Total Variable expenses	677100	183000	494100
Contribution margin	237900	122000	115900
Less: Direct Fixed Expesnes	122000	72000	50000
Segment Margin	115900	50000	65900
Less: Common fixed expenses	70500
Net Operating Income	45400

Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	237900
/Total Sales	915000
Contribution Margin ratio	26.000%
Total Companywide Fixed Costs (122000+70500)	192500
/Contribution Margin ratio	26.000%
Companywide Break even point in dollar sales	740385

Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	122000	115900
/Segment's Sales	305000	610000
Contribution Margin ratio	40.00%	19.00%
Direct Fixed Costs	72000	50000
/Contribution Margin ratio	40.00%	19.00%
Segment's Break even point in dollar sales	180000	263158

Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	305000	610000
Variable expenses:
Cost of goods sold	152500	433100
revised Sales commissions	15250	30500
Total Variable expenses	167750	463600
Contribution margin	137250	146400
Revised Contribution Margin ratio	45.00%	24.00%
Revised Direct Fixed Expesnes	94000	94000
/Contribution Margin ratio	45.00%	24.00%
Segment's Break even point in dollar sales	208889	391667