Question

Power Music owns five music stores, where it sells music, instruments, and supplies. In addition, it rents instruments. At the end of last year, the new accounts showed that although the business as a whole was profitable, the Fifth Avenue store had shown a substantial loss. The income statement for the Fifth Avenue store for last month follows:

POWER MUSIC Fifth Avenue Store Partial Income Statement
Sales				$	1,940,000
Cost of goods sold					1,675,000
Gross margin				$	265,000
Costs:
Payroll, direct labor, and supervisiona	$	152,000
Rentb		47,300
State taxesc		7,400
Insurance on inventory		54,200
Depreciationd		22,400
Administration and general officee		59,000
Interest for inventory carrying costsf		13,400
Total costs					355,700
Loss				$	(90,700	)

Additional computations:

^a These costs would be saved if the store were closed.

^b The rent would be saved if the store were closed.

^c Assessed annually on the basis of average inventory on hand each month.

^d 8.5% of cost of departmental equipment. The equipment has no salvage value, and Power Music would incur no costs in scrapping it.

^eAllocated on the basis of store sales as a fraction of total company sales. Management estimates that 10% of these costs allocated to the Fifth Avenue store could be saved if the store were closed.

^f Based on average inventory quantity multiplied by the company's borrowing rate for three-month loans.

Analysis of these results has led management to consider closing the Fifth Avenue store. Members of the management team agree that keeping the Fifth Avenue store open is not essential to maintaining good customer relations and supporting the rest of the company's business. In other words, eliminating the Fifth Avenue store is not expected to affect the amount of business done by the other stores.

Required:

a. Calculate the cost savings in closing the Fifth Avenue store. Cost Savings?

b. Should the Fifth Avenue store be closed?

Answer 1

a. Cost saving: Here we will calculate total cost savings in closing the fifth avenue store,

Payroll, Direct Labor and Supervisor = $152000

Rent = $47300

State Tax = $7400

Insurance on Inventory= $54200

Adminstration and General Expenses= $59000

Interest for Inventor= $13400

Total Cost could be saved from the data available = $33,33,00

b. Should the fifth avenue store be closed? To answer this we need more data about the business. As we can see from the financial data of the fifth avenue, total sales are $19,40,000 which is good enough if we compare it with the total loss of $90,700. In my opinion, Fifth Avenue should not be closed as it is having good sales. The company incurred loss due to high expenses which could be handled by the management. The company can reduce some expenses on payroll and general&office expenses.

They can work hard to increase sales which could cover the losses in the business. They can some of the assets which are no longer in use and use that money to gain some customer base. They can increase product prices to some extent which will increase sales for the company. There are many ways that can be used to cut down on losses. But if this business is having losses for many years, then closing this store would be beneficial.