Home Decor Company’s management is trying to decide whether to eliminate Department 200, which has produced losses or low profits for several years. The company’s 2011 departmental income statement shows the following.
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HOME DECOR COMPANY Departmental Income Statements For Year Ended December 31, 2011 |
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Dept. 100 |
Dept. 200 |
Combined |
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Sales |
$872,000 |
$580,000 |
$1,452,000 |
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Cost of goods sold |
524,000 |
414,000 |
938,000 |
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Gross profit |
348,000 |
166,000 |
514,000 |
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Operating expenses |
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|
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Direct expenses |
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|
|
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Advertising |
34,000 |
24,000 |
58,000 |
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Store supplies used |
8,000 |
7,600 |
15,600 |
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Depreciation—Store equipment |
10,000 |
6,600 |
16,600 |
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Total direct expenses |
52,000 |
38,200 |
90,200 |
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Allocated expenses |
|
|
|
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Sales salaries |
130,000 |
78,000 |
208,000 |
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Rent expense |
18,880 |
9,440 |
28,320 |
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Bad debts expense |
19,800 |
16,200 |
36,000 |
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Office salary |
37,440 |
24,960 |
62,400 |
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Insurance expense |
4,000 |
2,200 |
6,200 |
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Miscellaneous office expenses |
4,800 |
3,200 |
8,000 |
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Total allocated expenses |
214,920 |
134,000 |
348,920 |
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Total expenses |
266,920 |
172,200 |
439,120 |
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Net income (loss) |
$ 81,080 |
$ (6,200) |
$ 74,880 |
In analyzing whether to eliminate Department 200, management considers the following:
a. The company has one office worker who earns $1,200 per week, or $62,400 per year, and four salesclerks who each earn $1,000 per week, or $52,000 per year.
b. The full salaries of two salesclerks are charged to Department 100. The full salary of one salesclerk is charged to Department 200. The salary of the fourth clerk, who works half time in both departments, is divided evenly between the two departments.
c. Eliminating Department 200 would avoid the sales salaries and the office salary currently allocated to it. However, management prefers another plan. Two salesclerks have indicated that they will be quitting soon. Management believes that their work can be done by the other two clerks if the one office worker works in sales half time. Eliminating Department 200 will allow this shift of duties. If this change is implemented, half the office worker’s salary would be reported as sales salaries and half would be reported as office salary.
d. The store building is rented under a long term lease that cannot be changed. Therefore, Department 100 will use the space and equipment currently used by Department 200.
e. Closing Department 200 will eliminate its expenses for advertising, bad debts, and store supplies; 70% of the insurance expense allocated to it to cover its merchandise inventory; and 25% of the miscellaneous office expenses presently allocated to it.
Required
1. Prepare a three column report that lists items and amounts for (a) the company’s total expenses (including cost of goods sold) — in column 1, (b) the expenses that would be eliminated by closing Department 200 — in column 2, and (c) the expenses that will continue — in column 3.
2. Prepare a forecasted annual income statement for the company reflecting the elimination of Department 200 assuming that it will not affect Department 100’s sales and gross profit. The statement should reflect the reassignment of the office worker to one half time as a salesclerk.
3. Reconcile the company’s combined net income with the forecasted net income assuming that Department 200 is eliminated (list both items and amounts). Analyze the reconciliation and explain why you think the department should or should not be eliminated.