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	$	990,000		$	330,000		$	660,000
Cost of goods sold		663,300			181,500			481,800
Gross margin		326,700			148,500			178,200
Selling and administrative expenses		304,000			136,000			168,000
Net operating income	$	22,700		$	12,500		$	10,200

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 $63,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $82,000 of fixed expenses that would disappear if the Commercial segment is dropped, and $60,000 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 $13,500 and $27,000, 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	136000	168000
Less: Direct fixed expesnes	82000	60000
Less: variable Sales Commission (10% of sales)	33000	66000
Common Fixed expesnes allocated to Segments	21000	42000
Solution 2b:
	Commercial	Residential	Total
Total Sales	330000	660000	990000
Ratio	0.33	0.67
Common Fixed expesnes allocated to Segments	21000	42000	63000
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	990000	330000	660000
Variable expenses:
Cost of goods sold	663300	181500	481800
Sales commissions	99000	33000	66000
Total Variable expenses	762300	214500	547800
Contribution margin	227700	115500	112200
Less: Direct Fixed Expesnes	142000	82000	60000
Segment Margin	85700	33500	52200
Less: Common fixed expenses	63000
Net Operating Income	22700

Solution 5:
Companywide Break even point in dollar sales
	Total
Total Contribution margin	227700
/Total Sales	990000
Contribution Margin ratio	23.000%
Total Companywide Fixed Costs (142000+63000)	205000
/Contribution Margin ratio	23.000%
Companywide Break even point in dollar sales	891304
Solution 6:
Segment's Break even point in dollar sales
	Commercial	Residential
Segments Contribution margin	115500	112200
/Segment's Sales	330000	660000
Contribution Margin ratio	35.00%	17.00%
Direct Fixed Costs	82000	60000
/Contribution Margin ratio	35.00%	17.00%
Segment's Break even point in dollar sales	234286	352941

Solution 7:
Segment's Revised Break even point in dollar sales
	Commercial	Residential
Sales	330000	660000
Variable expenses:
Cost of goods sold	181500	481800
revised Sales commissions	16500	33000
Total Variable expenses	198000	514800
Contribution margin	132000	145200
Revised Contribution Margin ratio	40.00%	22.00%
Revised Direct Fixed Expesnes	95500	87000
/Contribution Margin ratio	40.00%	22.00%
Segment's Break even point in dollar sales	238750	395455