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	$	4,080,000		$	1,080,000		$	1,560,000		$	1,440,000
Cost of goods sold		2,254,800			604,800			858,000			792,000
Gross margin		1,825,200			475,200			702,000			648,000
Selling and administrative expenses:
Selling expenses:		1,160,800			346,600			428,400			385,800
Administrative expenses		610,140			178,240			228,580			203,320
Total expenses		1,770,940			524,840			656,980			589,120
Net operating income (loss)	$	54,260		$	(49,640	)	$	45,020		$	58,880

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	$	347,000	$	106,000	$	125,000	$	116,000
Direct advertising		241,000		69,000		90,000		82,000
General advertising*		61,200		16,200		23,400		21,600
Store rent		354,000		103,000		138,000		113,000
Depreciation of store fixtures		46,600		15,400		15,000		16,200
Delivery salaries		75,000		25,000		25,000		25,000
Depreciation of delivery equipment		36,000		12,000		12,000		12,000
Total selling expenses	$	1,160,800	$	346,600	$	428,400	$	385,800

*Allocated on the basis of sales dollars.

	Total		North Store		South Store		East Store
Administrative expenses:
Store management salaries	$	124,000	$	39,000	$	48,000	$	37,000
General office salaries*		81,600		21,600		31,200		28,800
Insurance on fixtures and inventory		48,400		12,900		18,000		17,500
Utilities		160,000		49,000		58,000		53,000
Employment taxes		94,140		28,740		34,380		31,020
General office —other*		102,000		27,000		39,000		36,000
Total administrative expenses	$	610,140	$	178,240	$	228,580	$	203,320

*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 $20,600 per quarter. The general manager of the North Store would be retained at her normal salary of $21,600 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 $22,000 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 $10,800 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 reductions or outflows should be indicated by a minus sign.)

          

b.	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.

Answer 1

1	The simplest approach to the solution is:
	Gross margin lost if the store is closed		($475,200)
	Costs that can be avoided:
	Sales salaries	106,000
	Direct advertising	69,000
	Store rent	103,000
	Delivery salaries	22,000
	Store management salaries
	($39,000 – $21,600)	17,400
	Salary of new manager	20,600
	General office compensation	10,800
	Insurance on inventories ($12,900 × 2/3)	8,600
	Utilities	49,000
	Employment taxes*	$        26,520	432,920
	Decrease in company profits if the North Store is closed		(42,280)
	*Salaries avoided by closing the store:
	Sales salaries	106,000
	Delivery salaries	22,000
	Store management salaries	17,400
	Salary of new manager	20,600
	General office compensation	10,800
	Total avoided	176,800
	Employment tax rate	x 15%
	Employment taxes avoided	$        26,520
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 $42,280 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 $103,000 rent cannot be avoided and the North Store is closed, the company’s overall net operating income would be reduced by $145,280 per quarter ($42,280 + $103,000).
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)		($475,200)
	Gross margin gained from the East Store: $1,080,000 × 1/4 = $270,000; $270,000 × 45%* = $121,500		121,500
	Net operating loss in gross margin		($353,700)
	Less costs that can be avoided if the North Store is closed (part 1)		432,920
a	Net advantage of closing the North Store		$79,220
	*The East Store’s gross margin percentage is: $648,000 ÷ $1,440,000 = 45%