Question

Superior Markets, Inc., operates three stores in a large metropolitan area. A segmented absorption costing income statement for the company for the last quarter is given below:

Superior Markets, Inc. Income Statement For the Quarter Ended September 30
	Total			North Store			South Store			East Store
Sales	$	3,700,000		$	800,000		$	1,480,000		$	1,420,000
Cost of goods sold		2,035,000			460,000			794,000			781,000
Gross margin		1,665,000			340,000			686,000			639,000
Selling and administrative expenses:
Selling expenses:		831,000			238,400			318,500			274,100
Administrative expenses		418,000			113,000			161,400			143,600
Total expenses		1,249,000			351,400			479,900			417,700
Net operating income (loss)	$	416,000		$	(11,400	)	$	206,100		$	221,300

The North Store has consistently shown losses over the past two years. For this reason, management is giving consideration to closing the store. The company has asked you to make a recommendation as to whether the store should be closed or kept open. The following additional
information is available for your use:

a. The breakdown of the selling and administrative expenses is as follows:

	Total		North Store		South Store		East Store
Selling expenses:
Sales salaries	$	214,800	$	59,700	$	72,200	$	82,900
Direct advertising		172,000		58,000		79,000		35,000
General advertising*		55,500		12,000		22,200		21,300
Store rent		335,000		92,000		127,000		116,000
Depreciation of store fixtures		19,500		5,300		6,700		7,500
Delivery salaries		23,100		7,700		7,700		7,700
Depreciation of delivery equipment		11,100		3,700		3,700		3,700
Total selling expenses	$	831,000	$	238,400	$	318,500	$	274,100

*Allocated on the basis of sales dollars.

	Total		North Store		South Store		East Store
Administrative expenses:
Store management salaries	$	80,500	$	24,500	$	33,500	$	22,500
General office salaries*		55,500		12,000		22,200		21,300
Insurance on fixtures and inventory		32,000		9,600		12,500		9,900
Utilities		101,415		31,315		35,860		34,240
Employment taxes		56,085		15,585		20,340		20,160
General office —other*		92,500		20,000		37,000		35,500
Total administrative expenses	$	418,000	$	113,000	$	161,400	$	143,600

*Allocated on the basis of sales dollars.

b. The lease on the building housing the North Store can be broken with no penalty.

c. The fixtures being used in the North Store would be transferred to the other two stores if the North Store were closed.

d. The general manager of the North Store would be retained and transferred to another position in the company if the North Store were closed. She would be filling a position that would otherwise be filled by hiring a new employee at a salary of $11,000 per quarter. The general manager of the North Store would be retained at her normal salary of $12,000 per quarter. All other employees in the store would be discharged.

e. The company has one delivery crew that serves all three stores. One delivery person could be discharged if the North Store were closed. This person’s salary is $4,700 per quarter. The delivery equipment would be distributed to the other stores. The equipment does not wear out through use, but does eventually become obsolete.

f. The company’s employment taxes are 15% of salaries.

g. One-third of the insurance in the North Store is on the store’s fixtures.

h. The “General office salaries” and “General office—other” relate to the overall management of Superior Markets, Inc. If the North Store were closed, one person in the general office could be discharged because of the decrease in overall workload. This person’s compensation is $6,000 per quarter.

Required:

1. Prepare a schedule showing the change in revenues and expenses and the impact on the company’s overall net operating income that would result if the North Store were closed. (Any losses/ reductions should be indicated by a minus sign.)

2. Based on your computations in (1) above, what recommendation would you make to the management of Superior Markets, Inc.?

	The North Store should be closed.
	The North Store should not be closed.

3. Assume that if the North Store were closed, at least one-fourth of its sales would transfer to the East Store, due to strong customer loyalty to Superior Markets. The East Store has enough capacity to handle the increased sales. You may assume that the increased sales in the East Store would yield the same gross margin as a percentage of sales as present sales in that store.

a. Calculate the net advantage of closing the North Store. (Any losses should be indicated by a minus sign.)

b. What recommendation would you make to the management of Superior Markets, Inc.?

Answer 1

1	The simplest approach to the solution is:
	Gross margin lost if the store is closed		($340,000)
	Costs that can be avoided:
	Sales salaries	59,700
	Direct advertising	58,000
	Store rent	92,000
	Delivery salaries	4,700
	Store management salaries
	($24,500 – $12,000)	12,500
	Salary of new manager	11,000
	General office compensation	6,000
	Insurance on inventories ($9,600 × 2/3)	6,400
	Utilities	31,315
	Employment taxes*	$        14,085	295,700
	Decrease in company profits if the North Store is closed		(44,300)
	*Salaries avoided by closing the store:
	Sales salaries	59,700
	Delivery salaries	4,700
	Store management salaries	12,500
	Salary of new manager	11,000
	General office compensation	6,000
	Total avoided	93,900
	Employment tax rate	x 15%
	Employment taxes avoided	$        14,085
2	Based on the data in (1), the North Store should not be closed. If the store is closed, then the company’s overall net operating income will decrease by $44,300 per quarter. If the store space cannot be subleased or the lease broken without penalty, a decision to close the store would cause an even greater decline in the company’s overall net income. If the $92,000 rent cannot be avoided and the North Store is closed, the company’s overall net operating income would be reduced by $136,300 per quarter ($44,300 + $92,000).
3	Under these circumstances, the North Store should be closed. The computations are as follows:
	Gross margin lost if the North Store is closed (part 1)		($340,000)
	Gross margin gained from the East Store: $800,000 × 1/4 = $200,000; $200,000 × 42.5%* = $85,000		85,000
	Net operating loss in gross margin		($255,000)
	Less costs that can be avoided if the North Store is closed (part 1)		295,700
a	Net advantage of closing the North Store		$40,700
	*The East Store’s gross margin percentage is: $340,000 ÷ $800,000 = 42.5%
b	North store should be closed now