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	$	900,000		$	300,000		$	600,000
Cost of goods sold		579,000			153,000			426,000
Gross margin		321,000			147,000			174,000
Selling and administrative expenses		280,000			124,000			156,000
Net operating income	$	41,000		$	23,000		$	18,000

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, $70,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $48,000 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.

	Toxaway Company Income Statement Total Company Commercial Residential Variable expenses: Total variable expenses

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 $21,000 and $42,000, 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	124000	156000
Less: Direct fixed expesnes	70000	48000
Less: variable Sales Commission (10% of sales)	30000	60000
Common Fixed expesnes allocated to Segments	24000	48000
Solution 2b:
	Commercial	Residential	Total
Total Sales	300000	600000	900000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	24000	48000	72000
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	900000	300000	600000
Variable expenses:
Cost of goods sold	579000	153000	426000
Sales commissions	90000	30000	60000
Total Variable expenses	669000	183000	486000
Contribution margin	231000	117000	114000
Less: Direct Fixed Expesnes	118000	70000	48000
Segment Margin	113000	47000	66000
Less: Common fixed expenses	72000
Net Operating Income	41000
Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	231000
/Total Sales	900000
Contribution Margin ratio	25.667%
Total Companywide Fixed Costs (118000+72000)	190000
/Contribution Margin ratio	25.667%
Companywide Break even point in dollar sales	740259
Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	117000	114000
/Segment's Sales	300000	600000
Contribution Margin ratio	39.00%	19.00%
Direct Fixed Costs	70000	48000
/Contribution Margin ratio	39.00%	19.00%
Segment's Break even point in dollar sales	179487	252632
Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	300000	600000
Variable expenses:
Cost of goods sold	153000	426000
revised Sales commissions	15000	30000
Total Variable expenses	168000	456000
Contribution margin	132000	144000
Revised Contribution Margin ratio	44.00%	24.00%
Revised Direct Fixed Expesnes	91000	90000
/Contribution Margin ratio	44.00%	24.00%
Segment's Break even point in dollar sales	206818	375000