Question

Problem 7-24

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	$	870,000		$	290,000		$	580,000
Cost of goods sold		571,300			153,700			417,600
Gross margin		298,700			136,300			162,400
Selling and administrative expenses		272,000			120,000			152,000
Net operating income	$	26,700		$	16,300		$	10,400

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 $75,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $66,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $44,000 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.

Answer 1

Requirement 1

1) we do not agree with intern's decision to use an absorption format for segmented income statement. Absorption costing system allocates all the variable and fixed expenses to different segments which is not helpful for analysis of operational and financial efficiency and for comparing product lines

Requirement 2

Requirement 21- a) Calculation for company's Common fixed a Expenses allocated by Inteon Amount T. Amount Particulars in $ in $ 272000 (87000) a) Total selling and administrative Expensec of Company bless : variable selling and administrative Expenvel C 870,00 X y C) fixed selling fodministrative Expene dlces! Freed Expenses of - Commercial segments eless: fixed Expenses of Reciclete segments 185ooo (68000) (44000) 5) common fixed Expenses 75000

b) Determination of Allocation based usey by intern to allocate common fixed Expensand calcolation of Ratios for allocation as per different Baves! Basen Tokee commercial Residentine Ratis a) sales 87150 290 1000 ,000 I!2 b) Cost of Goods 571 300 1537004176001537 : 4176 Sid c) Grors margin 298750 I 1363.50 162400 1363 1624 calculation for share of common Expenses Crixen allocated Particular Totol Commosciae Residentice Amount To tel fixed Expenses 272.000 1201000 152000 Cels: variable Expenses $7.000 (29000) (59000) Less Axey Expenses (110,000) (66000) (44000) Exclusively forcerred for segment Share of comman Exo 85ooo 25000 50,000 endo Ratio of Allocation is 25150 ie 1:2 Hene, Intern has used soles as a base for allocation of common fixed Expenses

Requirement 3

We do not agree with intern's decision to allocate common fixed expenses to commercial and residential segments as it may reduce profitability of efficient segment

Requirement 4

Regeirement 4. segmented Income statement using Contribut format Amouot in & Partiallars Totoe commerciae Reridentiels Sales 870, 800 290,000 5 so1000 less: cost of Goods Soid (571300) (1 53700) (417 800) cers! Variable selling (87000) (29000) (59000) and administrative Exp Contribution 211700 107300 I104,400 Other Fixed selling and (1101000) (66000) (444000) administrative Expenses comman fixel Expene (75000) ret income 26700 Ics Scanned with CamScanner