Elegant Decor Company’s management is trying to decide whether to eliminate Depa

Question

Elegant 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 2015 departmental income statements shows the following.

           ELEGANT DECOR COMPANY
Departmental Income Statements
For Year Ended December 31, 2015
Dept. 100   Dept. 200   Combined
Sales $437,000   $287,000   $724,000     
Cost of goods sold 262,000      214,000      476,000     
Gross profit 175,000      73,000      248,000     
Operating expenses

Direct expenses   

Advertising 18,000      13,500      31,500     
Store supplies used 4,500      4,000       8,500     
Depreciation—Store equipment 4,000      2,900       6,900     
Total direct expenses 26,500      20,400      46,900     
Allocated expenses   
Sales salaries 52,000      31,200       83,200     
Rent expense 9,440      4,720      14,160     
Bad debts expense 9,900      8,100       18,000     
Office salary 15,600      10,400      26,000     
Insurance expense 1,900      1,000      2,900     
Miscellaneous office expenses 2,100       1,500      3,600     
  Total allocated expenses 90,940       56,920      147,860     
   Total expenses 117,440      77,320      194,760
   Net income (loss) $57,560      $(4,320   )   $53,240     
     
         
      


In analyzing whether to eliminate Department 200, management considers the following:

a.  
The company has one office worker who earns $500 per week, or $26,000 per year, and four sales clerks who each earn $400 per week, or $20,800 per year for each salesclerk.
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; 74% of the insurance expense allocated to it to cover its merchandise inventory; and 20% of the miscellaneous office expenses presently allocated to it.

Explanation / Answer

Statement of showing the income of ELEGANT DÉCOR COMPANY if Department 200 has been eliminated. $ $ $ Dept. 100 Dept.200 Combined Sales 437000 0 437000 Cost of goods sold 262000 0 262000 Gross profit 175000 0 175000 Operating expenses Direct expenses Advertising 18000 0 18000 Store supplies used 4500 0 4500 Depreciation store equipment 6900 0 6900 Total direct expenses 29400 0 29400 Allocated expenses 0 Sales salaries 62400 0 62400 Rent expenses 14160 0 14160 Bad debt expenses 9900 0 9900 Office salary 28600 0 28600 Insurance expenses 1900 260 2160 Miscellaneous expenses 2100 1200 3300 Total allocated expenses 119060 1460 120520 Total expenses 148460 1460 149920 Net Income(Loss) 26540      (1,460) 25080 Conclusion: The combined net income of the company will be reduced to $25080 once Dept 200 is eliminated. Since decission taken by the management is not worthwile.

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