Question

Jackson County Senior Services is a nonprofit organization devoted to providing essential services to seniors who live in their own homes within the Jackson County area. Three services are provided for seniors—home nursing, Meals On Wheels, and housekeeping. Data on revenue and expenses for the past year follow:

		Total		Home Nursing		Meals On Wheels		House- keeping
Revenues	$	924,000	$	265,000	$	400,000	$	259,000
Variable expenses		464,000		114,000		197,000		153,000
Contribution margin		460,000		151,000		203,000		106,000
Fixed expenses:
Depreciation		70,200		8,400		40,800		21,000
Liability insurance		43,400		20,400		7,300		15,700
Program administrators’ salaries		116,000		40,600		38,700		36,700
General administrative overhead*		184,800		53,000		80,000		51,800
Total fixed expenses		414,400		122,400		166,800		125,200
Net operating income (loss)	$	45,600	$	28,600	$	36,200	$	(19,200)

*Allocated on the basis of program revenues.

The head administrator of Jackson County Senior Services, Judith Miyama, is concerned about the organization’s finances and considers the net operating income of $45,600 last year to be razor-thin. (Last year's results were very similar to the results for previous years and are representative of what would be expected in the future.) She feels that the organization should be building its financial reserves at a more rapid rate in order to prepare for the next inevitable recession. After seeing the above report, Ms. Miyama asked for more information about the financial advisability of perhaps discontinuing the housekeeping program.

The depreciation in housekeeping is for a small van that is used to carry the housekeepers and their equipment from job to job. If the program were discontinued, the van would be donated to a charitable organization. None of the general administrative overhead would be avoided if the housekeeping program were dropped, but the liability insurance and the salary of the program administrator would be avoided.

Required:

1-a.	What is the impact on net operating income by discontinuing housekeeping program? (Decreases should be indicated by a minus sign.)

          

1-b.	Should the housekeeping program be discontinued?
	Yes No

  

2-a.	Prepare a segmented income statement.

          

2-b.	Would a segmented income statement format be more useful to management in assessing the long-run financial viability of the various services.
	Yes No

Answer 1

Solution

Jackson County Senior Services

1a. Determination of the impact on net income by discontinuing housekeeping program:

	Continue Housekeeping	Discotinue Housekeeping
Revenues	$259,000	0
Variable expenses	$153,000	0
Contribution margin	$106,000	0
Fixed expenses:
Depreciation	$21,000	$21,000
Liability Insurance	$15,700	0
Program administrator's salary	$36,700	0
Total direct fixed costs	$73,400	$21,000
Operating Margin /(loss)	$32,600	($21,000)
General admin overhead	$51,800	$51,800
Total fixed expenses	$125,200	$72,800
Net operating income/(loss)	($19,200)	($72,800)

Notes: Depreciation expense is incurred as the asset has been donated and not disposed.

The general administration overhead is an allocated cost.

1b. No – The housekeeping program should not be discontinued.

Explanation: The housekeeping program earns a contribution margin of $106,000 and an operating margin of $32,600 after providing for the direct traceable fixed costs. The operating margin of $32,600 considerably absorbs common allocated fixed of $51,800 to leave a net loss of $19,200.

Discontinuation of housekeeping program would result a contribution margin loss of $106,000, which would increase net loss by $53,600. Furthermore, the program reports an operating loss of $21,000 as well as an overall net loss of $72,800, which is relatively higher than the overall net loss incurred when the program is continued. The net loss is due to the presence of unavoidable traceable fixed costs (depreciation) and the allocated general administration overhead. Hence, the Housekeeping program should not be discontinued.

2a. Segmented Income Statement:

	Home Nursing	Meals on Wheels	Housekeeping	Total
Revenues	$265,000	$400,000	$259,000	$924,000
Variable expenses	$114,000	$197,000	$153,000	$464,000
Contribution margin	$151,000	$203,000	$106,000	$460,000
Fixed expenses:
Depreciation	$8,400	$40,800	$21,000	$70,200
Liability Insurance	$20,400	$7,300	$15,700	$43,400
Program administrator's salary	$40,600	$38,700	$36,700	$116,000
Total direct fixed costs	$69,400	$86,800	$73,400	$229,600
Operating Margin /(loss)	$81,600	$116,200	$32,600	$230,400
General admin overhead	$53,000	$80,000	$51,800	$184,800
Net operating income/(loss)	$28,600	$36,200	($19,200)	$45,600

2b. Answer – Yes

Segmented income statement format is more useful to management in assessing the long-run financial viability of the various services.

Segmented income statement format provides management with information about traceable or avoidable fixed costs as well as allocated overhead costs and their impact on the segment income and the overall net income. This helps management understand the financial feasibility of various services to absorb direct fixed costs as well as allocated fixed costs.

The services are viable as long as they earn enough contribution margin to absorb the direct traceable fixed costs. The contribution margin of the services might not be adequate to absorb the common allocated fixed costs but still the service is viable as long it earns contribution margin to leave segment margin.