College Accounting: P25-6B Esme Company
Problem 25-6B Analysis of possible elimination of a department
Esme 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 2016 departmental income statements show the following.
Department Income Statements
For the Year Ended December 31, 2016
Dept A Dept Z Combined
Sales 700,000 175,000 875,000
Cost of Goods Sold 461,300 125,100 586,400
Gross Profit 238,700 49,900 288,600
Advertising 27,000 3,000 30,000
Store Supplies used 5,600 1,400 7,000
Deprec. Store Equipment 14,000 7,000 21,000
Total Direct Expenses 46,600 11,400 58,000
Sales Salaries 70,200 23,400 93,600
Rent Expense 22,080 5,520 27,600
Bad Debts Expense 21,000 4,000 25,000
Office Salary 20,800 5,200 26,000
Insurance Expense 4,200 1,400 5,600
Misc. Office Expenses 1,700 2,500 4,200
Total Allocated Expenses 139,980 42,020 182,000
Total Expenses 186,580 53,420 240,000
Net Income (Loss) 52,120 -3,520 48,600
In analyzing whether or not to eliminate Department Z, management considers the following items:
a. The company has one office worker who earns $500 per week or $26,000 per year and four salesclerks who each earn $450 per week or $23,400 per year for each sales clerk.
b. The full salaries of three sales clerks are charged to Department A. The full salary of one sales clerk 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 sales clerks 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 the shift of duties. If this change is implemented, half of 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.
1. Prepare a three-column spreadsheet 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. (10 pts.) _______
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 sales clerk. (10 pts.) _________
3. Reconcile the company's combined net income with the forecasted net income assuming that Department Z is eliminated (list both items and amounts). Analyze the reconciliation and explain why you think the department should or should not be eliminated.
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