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:

Income Statement For the Quarter Ended September 30 North South Total Store Store Sales $3,400,000 $740,000 $1,360,000 Cost of goods sold 1,870,000 420,000 735,000 Gross margin 1,530,000 320,000 625,000 Selling and administrative expenses: Selling expenses 825,000 235,400 317,000 Administrative expenses 403,000 110,000 156,900 Total expenses 1,228,000 345,400 473,900 Net operating income (loss) $ 302,000 $125,400) $ 151,100 East Store $1,300,000 715,000 585,000 272,600 136,100 408, 700 176,300 $ The North Store has consistently shown losses over the past two years. For this reason, management is giving consideration to closing pany 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 that are shown above is as follows: Total North Store South Store East Store Selling expenses: Sales salaries Direct advertising General advertising Store rent Depreciation of store fixtures Delivery salaries Depreciation of delivery equipment Total selling expenses $220,600 183,000 51,000 320,000 18,000 22, 200 10,200 $ 64,500 55,000 11,100 89,000 5,000 7,400 3,400 $ 79,400 76,000 20,400 124,000 6,400 7,400 3,400 $ 76,700 52,000 19,500 107,000 6,600 7,400 3,400 $825,000 $235, 400 $317,000 $272,600 *Allocated on the basis of sales dollars. North Store South Store East Store Total $ 76,000 51,000 29,000 Administrative expenses: Store managers' salaries General office salaries* Insurance on fixtures and inventory Utilities Employment taxes General office-other* Total administrative expenses 106,530 55, 470 85,000 $403,000 $ 23,000 11,200 8,700 32,685 15,915 18,500 $110,000 $32,000 20,400 11,000 38,620 20,880 34,000 $156,900 $ 21,000 19,400 9,300 35,225 18,675 32,500 $136,100

*Allocated on the basis of sales dollars.

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

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

4. 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 $10,200 per quarter. The general manager of the North Store would continue to earn her normal salary of $11,200 per quarter. All other managers and employees in the North store would be discharged.

5. 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 $4,400 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.

6. The company pays employment taxes equal to 15% of their employees' salaries.

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

8. 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 $5,600 per quarter.

Required:

1. How much employee salaries will the company avoid if it closes the North Store?

2. How much employment taxes will the company avoid if it closes the North Store?

3. What is the financial advantage (disadvantage) of closing the North Store?

4. Assuming that the North Store's floor space can’t be subleased, would you recommend closing the North Store?

5. Assume that the North Store's floor space can’t be subleased. However, let's introduce three more assumptions. First, assume that if the North Store were closed, one-fourth of its sales would transfer to the East Store, due to strong customer loyalty to Superior Markets. Second, assume that the East Store has enough capacity to handle the increased sales that would arise from closing the North Store. Third, assume that the increased sales in the East Store would yield the same gross margin as a percentage of sales as present sales in the East store. Given these new assumptions, what is the financial advantage (disadvantage) of closing the North Store?

Answer 1

1) Employee Salaries which can be avoided if the company closes the North Store are -

i) Sales Salaries $64,500

ii) Delivery Salaries    $4,400

iii) Store Management Salaries ($23,000 - $11,200) $11,800

iv) New Manager Salary $10,200

v) General Office Salaries $6,300

Total Salaries that can be avoided (i+ii+iii+iv+v) = $97,200

2) Employment taxes which can be avoided if it closes the North Store = Salaries which can be avoided * Rate of Employment Tax

= $97,200 * 15%

= $14,580

3) Financial advantage/ (disadvantage) of closing the North Square  

Gross Margin Lost if North store is closed ($320,000)

Add: Savings in cost ($294,265 - as described below)   

Store Rent $89,000

Sales Salaries $64,500

Direct Advertising $55,000

Delivery Salaries $4,400

Store Management Salaries $11,800

Salary of New Manager $10,200

General Office Salaries $6,300

Insurance ($8,700 * 2/3) $5,800

Utilities $32,685

Employment Taxes $14,580

Decrease in Net Profit if North store is closed = $25,735

(Gross Profit - Total savings in cost)

Therefore, Financial disadvantage of closing North store is $25,735

4) The company would be $25,735 worse off per quarter if it closed the North Store. If the store space cannot be subleased or the lease broken without penalty, a decision to close the store would become even less viable. If the $89,000 rent cannot be avoided and the North Store is closed, the financial (disadvantage) of closing the North Store would grow from $(25,735) to $(114,735) per quarter.

5) Gross Margin (%) earned from East Store = Gross Margin / Sales

= $585,000 / $1,300,000

= 45%

Sales transferred from North to East store = 1/4th of North store sales

=1/4 * $740,000

= $185,000

Gross margin earned by East store on sales transferred by North store = $185,000 * 45%

= $83,250

If floor space can't be subleased,Then threre is nosavings in store rent. Therefore, Savings in cost = $294,265 - $89,000

= $205,265

Gross Margin Lost if North store closed    ($320,000)

Add : Gross margin earned from East store $83,250

Net Gross Margin Lost ($236,750)

Savings in cost $205,265

Net disadvantage of Closing the North store ($31,485)