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	$	1,005,000		$	335,000		$	670,000
Cost of goods sold		670,000			180,900			489,100
Gross margin		335,000			154,100			180,900
Selling and administrative expenses		308,000			138,000			170,000
Net operating income	$	27,000		$	16,100		$	10,900

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 $61,500 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $84,000 of fixed expenses that would be avoided if the Commericial segment is dropped, and $62,000 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 $14,500 and $29,000, 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

As per HomeworkLib policy the first four parts are answered.

1	Do you agree with the intern’s decision to use an absorption format for her segmented income statement?
	The idea of making a segmented income statement by the use of absorption costing is not a good idea based
	on the following grounds:
	*It does not focus on cost behavior.
	*In absorption costing the costs are not segregated into fixed and variable so it does not help in making a break even
	analysis which is available in case of an variable costing method.
2-a & b	In the current scenario the total selling and administrative costs have been allocated to the divisions based on
	their gross margin ratio.
	Calculation of Gross Margin Ratio is calculated for both the divisions as below:
	Gross Margin of C Division	Gross Margin of C/Gross Margin of Total Company
		154100/335000
		46%
	Gross Margin of D Division	Gross Margin of D/Gross Margin of Total Company
		180900/335000
		54%
	Selling and administrative Expenses have been allocated based on the gross margin ratio
	Particulars	Commercial Division S	Residential Division	Total Company
	Selling and administrative Exp	138000	170000	308000
	Less Sales Commission
	10% on sales	-33500	-67000	-100500
	335000*.1,670000*.1,1005000*.1
	Less Avoidable Fixed Costs	-84000	-62000	-146000
	Common Fixed Costs	20500	41000	61500
3	The decision cannot be agreed with respect to allocation of fixed expenses as there are
	traceable fixed costs and variable component of selling and admin costs which is segregated to each division
4	Redo the intern’s segmented income statement using the contribution format
		I's Segmented Income Statement (using the contribution format)
	Particulars	Commercial Division S	Residential Division	Total Company
	Sales	335000	670000	1005000
	Less Variable Exp
	Cost of Goods Sold	180900	489100	670000
	Variable Selling and Admin	33500	67000	100500
	Total Variable Cost	214400	556100	770500
	Contribution Margin	120600	113900	234500
	Less Traceable Fixed Cost	84000	62000	146000
	Segment Margin	36600	51900	88500
	Less Common Fixed Cost			61500
	Net Operating Income			27000
	Total Fixed Cost(Traceable+Common)			207500