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	$	765,000		$	255,000		$	510,000
Cost of goods sold		510,000			142,800			367,200
Gross margin		255,000			112,200			142,800
Selling and administrative expenses		244,000			106,000			138,000
Net operating income	$	11,000		$	6,200		$	4,800

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 $85,500 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $52,000 of fixed expenses that would be avoided if the Commericial segment is dropped, and $30,000 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 $12,000 and $24,000, 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	106,000	138,000
Less: Sales Commission	25,500	51,000
Less: Traceable fixed expenses	52,000	30,000
Common Expenses Allocated	28,500	57,000
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	765,000	255,000	510,000
Less: Variable Expenses
Cost of Goods Sold	510,000	142,800	367,200
Selling and Admin Expenses	76,500	25,500	51,000
Contribution Margin	178,500	86,700	91,800
Less: Traceable Fixed Expenses	82,000	52,000	30,000
Segment Margin	96,500	34,700	61,800
Less: Common Fixed Expenses	85,500
Net Operating Income	11,000
5.Contribution Margin Ratio = Contribution Margin/Sales
=178500/765000 = 23.33%
Break even point = Fixed costs/CM Ratio
=(82,000+85,500)/23.33% = $717,959.71
6. Commercial Division = 52,000/34% = $152,941.18
Residential = 30,000/18% = $166,666.67
7.Commercial = (52,000+12,000)/39% = $164,102.56
Residential = (30,000+24,000)/23% = $234,782.61