Question

The Tilots Corporation’s segmented absorption costing income statement for the last quarter for its three metropolitan stores is given below:

Total	Uptown Store	Downtown Store	Westpark Store
Sales	$2,500,000	$900,000	$600,000	$1,000,000
Cost of goods sold	1,450,000	513,000	372,000	565,000
Gross margin	1,050,000	387,000	228,000	435,000
Selling and administrative expenses:
Selling expenses:
Direct advertising	118,500	40,000	36,000	42,500
General advertising*	20,000	7,200	4,800	8,000
Sales salaries	157,000	52,000	45,000	60,000
Delivery salaries	30,000	10,000	10,000	10,000
Store rent	215,000	70,000	65,000	80,000
Depreciation of store fixtures	46,950	18,300	8,800	19,850
Depreciation of delivery equipment	27,000	9,000	9,000	9,000
Total selling expenses	614,450	206,500	178,600	229,350
Administrative expenses:
Store management salaries	63,000	20,000	18,000	25,000
General office salaries*	50,000	18,000	12,000	20,000
Utilities	89,800	31,000	27,200	31,600
Insurance on fixtures and inventory	25,500	8,000	9,000	8,500
Employee benefits	36,000	12,000	10,200	13,800
General office expenses—other*	25,000	9,000	6,000	10,000
Total administrative expenses	289,300	98,000	82,400	108,900
Total operating expenses	903,750	304,500	261,000	338,250
Operating income (loss)	$ 146,250	$ 82,500	$(33,000)	$ 96,750
*Allocated on the basis of sales dollars

Management is very concerned about the Downtown Store’s inability to show a profit, and consideration is being given to closing the store. The company has asked you recommend a course of action. Additional information available on the store is provided below:

1. The manager of the store has been with the company for many years; he would be retained and transferred to another position in the company if the Downtown Store were closed. His salary is $6,000 per month, or $18,000 per quarter. If the store were not closed, a new employee would be hired to fill the other position at a salary of $5,000 per month.

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

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

4. Employee benefits are 12% of salaries.

5. Page 568A single delivery crew serves all three stores. One delivery person could be discharged if the Downtown Store were closed; this person’s salary amounts to $7,000 per quarter. The delivery equipment would be distributed to the other stores. The equipment does not wear out through use, but it does eventually become obsolete.

6. One-third of the Downtown Store’s insurance relates to its fixtures.

7. The general office salaries and other expenses relate to the general management of the Tilots Corporation. The employee in the general office who is responsible for the Downtown Store would be discharged if the store were closed. This employee’s compensation amounts to $8,000 per quarter.

Required:

1. Prepare a schedule showing the change in revenues and expenses and the impact on the overall company operating income that would result if the Downtown Store were closed.

2. Based on your computations in (1) above, what would you recommend to the management of the Tilots Corporation?

3. Assume that if the Downtown Store were closed, sales in the Uptown Store would increase by $200,000 per quarter due to loyal customers shifting their buying to the Uptown Store. The Uptown Store has ample capacity to handle the increased sales, and its gross margin is 43% of sales. What effect would these factors have on your recommendation concerning the Downtown Store? Show computations.

Problem 12-23 DROPPING A SEGMENT *Salaries avoided by closing the store: Sales salaries Delivery salaries... Store management salaries. General office salaries Total salaries....... Employee benefit rate..... Employee benefits avoided X 12% 1. The simplest approach to the solution is: Gross margin lost if the store is closed..... Less costs that can be avoided: Direct advertising.... Sales salaries..... Delivery salaries Store rent...... Store management salaries General office salaries ..... LILHL:

Answer 1

1.   The simplest approach to the solution is:

Gross margin lost if the store is closed............................		$(228,000)
Less costs that can be avoided:
Direct advertising........................................................	$36,000
Sales salaries................................................................	45,000
Delivery salaries...........................................................	7,000
Store rent.....................................................................	65,000
Store management salaries (new employee would not be hired to fill vacant position at another store).......	15,000
General office salaries..................................................	8,000
Utilities........................................................................	27,200
Insurance on inventories (2/3 × $9,000)......................	6,000
Employee benefits*.....................................................	9,000	218,200
Decrease in company operating income if the Downtown Store is closed...........................................		$(   9,800)

*Salaries avoided by closing the store:
	Sales salaries.....................................................................................	$45,000
	Delivery salaries................................................................................	7,000
	Store management salaries................................................................	15,000
	General office salaries......................................................................	8,000
	Total salaries.....................................................................................	75,000
	Employee benefit rate.......................................................................	×  12%
	Employee benefits avoided..............................................................	$ 9,000

2.   The Downtown Store should not be closed. If the store is closed, overall company operating income will decrease by $9,800 per quarter.

3.   The Downtown Store should be closed if $200,000 of its sales are picked up by the Uptown Store. The net effect of the closure will be an increase in overall company net operating income by $76,200 per quarter:

Gross margin lost if the Downtown Store is closed.........................................	$(228,000)
Gross margin gained at the Uptown Store: $200,000 × 43%............................................................................................	86,000
Net loss in gross margin....................................................................................	(142,000)
Costs that can be avoided if the Downtown Store is closed (part 1)...............	218,200
Net advantage of closing the Downtown Store...............................................	$  76,200