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	$	885,000		$	295,000		$	590,000
Cost of goods sold		572,300			153,400			418,900
Gross margin		312,700			141,600			171,100
Selling and administrative expenses		276,000			122,000			154,000
Net operating income	$	36,700		$	19,600		$	17,100

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 $73,500 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $68,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $46,000 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.

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 $20,000 and $40,000, 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

1.No, do not agree
2.a.
Allocation of common expenses is as follows
	Commercial	Residential
Selling and Admin Expenses	122,000	154,000
Less: Sales Commission	29,500	59,000
Less: Traceable fixed expenses	68,000	46,000
Common Expenses Allocated	24,500	49,000
b.Sales, is used since expenses allocated in the ratio of 1:2
3.No, Since common expenses are unavoidable
4.Contribution Margin format Income Statement
	Total	Commercial	Residential
Sales	885,000	295,000	590,000
Less: Variable Expenses
Cost of Goods Sold	572,300	153,400	418,900
Selling and Admin Expenses	88,500	29,500	59,000
Contribution Margin	224,200	112,100	112,100
Less: Traceable Fixed Expenses	114,000	68,000	46,000
Segment Margin	110,200	44,100	66,100
Less: Common Fixed Expenses	73,500
Net Operating Income	36,700
5.Contribution Margin Ratio = Contribution Margin/Sales
25.33%
Break even point = Fixed costs/CM Ratio
=(114,000+73500)/25.33%=740,228.98
6. Commercial Division = 68,000/38% = $178,947.37
Residential = 46,000/19% = $242,105.26
7.Commercial = (68,000+20,000)/43% = $204,651.16
Residential = (46,000+40,000)/24% = $358,333.33