Relevant Cost Saul’s Company\'s management is trying to decide whether to elimin
ID: 2566567 • Letter: R
Question
Relevant Cost Saul’s Company's management is trying to decide whether to eliminate Department Z, which has produced low profits or losses for several years. The company's 2014 departmental income statement shows the following.
Saul Company
Departmental Income Statement
For year ended December 31, 2014
Department A Department Z Combined
Sales $350,000 $87,500 $437,500
Cost of goods sold 230,650 62,550 293,200
Gross profit 119,350 24,950 144,300
Operating expenses Advertising 13,500 1,500 15,000
Store supplies used 2,800 700 3,500
Depreciation – store 7,000 3,500 10,500
Total direct expense 23,300 5,700 29,000
Allocated expenses
Sales salaries 35,100 11,700 46,800
Rent expense 11,040 2,760 13,800
Bad debts 10,500 2,000 12,500
Office salary 10,400 2,600 13,000
Insurance expense 2,100 700 2,800
Miscellaneous office expense 850 1,250 2,100
Total allocated expense 69,990 21,010 91,000
Total expenses 93,290 26,710 120,000
Net income 26,060 (1,760) 24,300
In analyzing whether to eliminate Department Z, management considers the following items:
a. The company has one office worker who earns $ 250 per week or $ 13,000 per year and four salesclerks who each earn $ 225 per week or $ 11,700 per year.
b. The full salaries of three salesclerks are charged to Department A. The full salary of one salesclerk is charged to Department Z.
c. Eliminating Department Z 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 two remaining clerks if the one office worker works in sales half-time. Eliminating Department Z 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 A will use the space and equipment currently used by Department Z.
e. Closing Department Z will eliminate its expenses for advertising, bad debts, and store supplies; 65% of the insurance expense allocated to it to cover its merchandise inventory; and 30% 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 Z—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 Z assuming that it will not affect Department A's sales and gross profit. The statement should reflect the reassignment of the office worker to one-half time as a salesclerk.
Explanation / Answer
Total Expenses Eliminated Expenses Continuing Expenses Cost of goods sold 293200 62550 230650 Operating expenses: 0 Advertising 15000 1500 13500 Store supplies used 3500 700 2800 Depreciation-Store 10500 0 10500 Total direct expense 29000 2200 26800 Allocated expenses: Sales salaries 46800 23400 23400 Rent expense 13800 2760 11040 Bad debts 12500 2000 10500 Office salary 13000 0 6500 Insurance expense 2800 455 2345 Miscellaneous office expense 2100 375 1725 Total allocated expense 91000 28990 62010 Total expenses 413200 93740 319460 FORECASTED ANNUAL INCOME STATEMENT Sales 350000 Cost of goods sold 230650 Gross profit 119350 Operating expenses: Advertising 13500 Store supplies used 2800 Depreciation-Store 10500 Sales salaries 29900 Rent expense 11040 Bad debts 10500 Office salary 6500 Insurance expense 2345 Miscellaneous office expense 1725 Total operating expenses 88810 Net income 30540 Note: The total expenses eliminated are $93,740 and the total revenues lost are $87,500. This results in the increase of combined net income by $6,240 Hence, department Z should be closed.