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 Sales Cost of goods sold Gross margin Selling and administrative expenses Net operating income $ 960,000 636,800 323,200 296,000 $ 27,200 Commercial Residential $ 320,000 $ 640,000 169,600 467,200 150,400 172,800 132,000 __ 164,000 $ 18,400 $ 8,800 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 $66,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $78,000 of fixed expenses that would be avoided if the Commercial segment is dropped, and $56,000 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 $25,000 and $50,000, 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. Complete this question by entering your answers in the tabs below. Reg 1 Req 2A Req 2B Reg 3 Reg 4 Reg 5 Req 6 Reg 7 Do you agree with the intern's decision to use an absorption format for her segmented income statement? Yes ON

Answer 1

1	No.
	Absorption format is used to report to the outside parties.
	It is appropriate to use contribution format for the decision making purpose
2
a.						Commercial	Residential
	Total selling and administrative expenses					132000	164000
	Less:
	Sales commission			(Sales*10%)		32000	64000
	Specific fixed expenses					78000	56000
						110000	120000
	Common fixed expenses allocated					22000	44000
b.	Ratio of common fixed expenses allocated=22000:44000 or 1:2
	Ratio of sales=320000:640000 or 1:2
	Hence, sales would have been used as the allocation base
3	No.
	Common fixed expenses should not be allpcated to products since it is not directly related to the product.
	It will distort the operating income
4						Commercial	Residential	Total company
	Sales				A	320000	640000	960000
	Less:Variable expenses
	Cost of goods sold					169600	467200	636800
	Selling and administrative expenses (10% of sales)					32000	64000	96000
	Total variable expenses				B	201600	531200	732800
	Contribution margin				C=A-B	118400	108800	227200
	Contribution margin ratio				D=C/A	0.37	0.17	0.24
	Less:Fixed selling and administrative expenses				E	78000	56000	134000
	Segment operating income				F=C-E	40400	52800	93200
5	Companywide break-even point in dollar sales=Total fixed expenses including common fixed expenses/Total contribution margin ratio=(134000+66000)/0.24=833333.3=$ 833333
6	Break-even point for commercial division=Specific fixed expenses/Contribution margin ratio=78000/0.37=$ 210811
	Break-even point for residential division=Specific fixed expenses/Contribution margin ratio=56000/0.17=$ 329412
7
						Commercial	Residential	Total company
	Sales				A	320000	640000	960000
	Less:Variable expenses
	Cost of goods sold					169600	467200	636800
	Selling and administrative expenses (5% of sales)					16000	32000	48000
	Total variable expenses				B	185600	499200	684800
	Contribution margin				C=A-B	134400	140800	275200
	Contribution margin ratio				D=C/A	0.42	0.22	0.29
	Less:Fixed selling and administrative expenses				E	103000	106000	209000
						(78000+25000)	(56000+50000)
	Segment operating income				F=C-E	31400	34800	66200
	Break-even point for commercial division=Specific fixed expenses/Contribution margin ratio=103000/0.42=$ 245238
	Break-even point for residential division=Specific fixed expenses/Contribution margin ratio=106000/0.22=$ 481818