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

$ 960,000 $ 320,000 $ 640,000

Cost of goods sold 636,800 169,600 467,200

Gross margin 323,200 150,400 172,800

selling and administrative expenses 296,000 132,000 164,000

Net operating income $ 27,200 $ 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.

Answer 1

Ans 1)
Interim decision to use an absorption format for her segmented income statement is not appropriate
because absorption costing method is beneficial for external reporting purpose, for internal reporting
purpose contribution format is best.
Ans 2a)
	Total	Commercial	Residential
Total selling & Administrative Expenses=(A)	$            2,96,000.00	$                   1,32,000.00	$                  1,64,000.00
Traceable Fixed Expenses	$            1,34,000.00	$                       78,000.00	$                     56,000.00
Sales Commission(10% of Sales)	$               96,000.00	$                       32,000.00	$                     64,000.00
selling & Administrative Expenses accounted for=(B)	$            2,30,000.00	$                   1,10,000.00	$                  1,20,000.00
Common Fixed Expenses=(A)-(B)	$               66,000.00	$                       22,000.00	$                     44,000.00
Common fixed Expenses allocated to
Commercial Division	$               22,000.00
Residential Division	$               44,000.00
Total Common Expenses	$               66,000.00
Sales Percentage of Commercial division=($320000/$960000)	33.33%
Sales Percentage of Residential division=($640000/$960000)	66.67%
2b)
Common Fixed Expenses allocated on the basis of sales dollars
($66000*33.33%)	$               22,000.00
($66000*66.67%)	$               44,000.00
3)
Allocated common fixed expenses between Commercial and Residential division is not appropriate
because this cost not traceable to segments & not affected segment level decision.
4)
Contribution Format segmented Income Statement
	Total Company	Commercial Division	Residential Division
Sales=(A)	$            9,60,000.00	$                   3,20,000.00	$                  6,40,000.00
Variable cost
Cost of goods sold	$            6,36,800.00	$                   1,69,600.00	$                  4,67,200.00
Commission=(A)*10%	$               96,000.00	$                       32,000.00	$                     64,000.00
Total Variable Expenses=(B)	$            7,32,800.00	$                   2,01,600.00	$                  5,31,200.00
Contribution Margin=(C)=(A)-(B)	$            2,27,200.00	$                   1,18,400.00	$                  1,08,800.00
Traceable Fixed Expenses=(D)	$            1,34,000.00	$                       78,000.00	$                     56,000.00
Segment Margin=(E )=(C )-(D)	$               93,200.00	$                       40,400.00	$                     52,800.00
Common Fixed Expenses=(F)	$               66,000.00
Net Operating Income=(E )-(F)	$               27,200.00
5) Companywide Breakeven point
Total contribution Margin	$            2,27,200.00
Total Sales	$            9,60,000.00
Total fixed Expenses
Common Fixed Expenses	$               66,000.00
Traceable Fixed Expenses	$            1,34,000.00
Total fixed Expenses	$            2,00,000.00
Contribution Margin Ratio=(Total contribution margin/Total Sales)=($227200/$960000)*100	24%
Break even point=Total Fixed Expenses/Contribution margin ratio=($200000/24%)	$                  8,45,070
6) Break even point of commercial division
Contribution margin=(A)	$            1,18,400.00
Sales=(B)	$            3,20,000.00
Contribution margin ratio=(A)/(B)*100	37%
Traceable Fixed Expenses	78000
Break even point=(Fixed Expenses/Contribution margin ratio)=($78000/37%)	$                  2,10,811
6) Break even point of Residential division
Contribution margin=(A)	$            1,08,800.00
Sales=(B)	$            6,40,000.00
Contribution margin ratio=(A)/(B)*100	17%
Traceable Fixed Expenses	56000
Break even point=(Fixed Expenses/Contribution margin ratio)=($56000/17%)	$                  3,29,412