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 2017 departmental income statements show
the following.
ESME COMPANY
Departmental Income Statements
For Year Ended December 31, 2017
Dept. A Dept. Z Combined
Sales . \(700,000 \)175,000 \(875,000
Cost of goods sold 461,300 125,100 586,400
Gross profit 238,700 49,900 288,600
Operating expenses
Direct expenses
Advertising 27,000 3,000 30,000
Store supplies used 5,600 1,400 7,000
Depreciation—Store equipment . 14,000 7,000 21,000
Total direct expenses 46,600 11,400 58,000
Allocated expenses
Sales salaries . 70,200 23,400 93,600
Rent expense 22,080 5,520 27,600
Bad debts expense 21,000 4,000 25,000
Office salary . 20,800 5,200 26,000
Insurance expense . 4,200 1,400 5,600
Miscellaneous office expenses . 1,700 2,500 4,200
Total allocated expenses 139,980 42,020 182,000
Total expenses . 186,580 53,420 240,000
Net income (loss) . \) 52,120 \( (3,520) \) 48,600
In analyzing whether 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 earns \(450 per week, or \)23,400 per year for each salesclerk.
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.
Analysis Component
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.
Kando Company incurs a \(9 per unit cost for Product A, which it currently manufactures and sells for \)13.50 per unit. Instead of manufacturing and selling this product, the company can purchase it for \(5 per unit and sell it for \)12 per unit. If it does so, unit sales would remain unchanged and \(5 of the \)9 per unit costs of Product A would be eliminated. Should the company continue to manufacture Product A or purchase it for resale?
Calla Company produces skateboards that sell for \(50 per unit. The company currently has the capacity to produce 90,000 skateboards per year, but is selling 80,000 skateboards per year. Annual costs for 80,000 skateboards follow.
Direct materials . \) 800,000
Direct labor 640,000
Overhead . 960,000
Selling expenses 560,000
Administrative expenses . 480,000
Total costs and expenses \(3,440,000
A new retail store has offered to buy 10,000 of its skateboards for \)45 per unit. The store is in a different market from Calla’s regular customers and would not affect regular sales. A study of its costs in anticipation
of this additional business reveals the following:
Direct materials and direct labor are 100% variable.
Thirty percent of overhead is fixed at any production level from 80,000 units to 90,000 units; the remaining
70% of annual overhead costs are variable with respect to volume.
Selling expenses are 60% variable with respect to number of units sold, and the other 40% of selling expenses are fixed.
There will be an additional \(2 per unit selling expense for this order.
Administrative expenses would increase by a \)1,000 fixed amount
Required
1. Prepare a three-column comparative income statement that reports the following:
a. Annual income without the special order.
b. Annual income from the special order.
c. Combined annual income from normal business and the new business.
2. Should Calla accept this order? What nonfinancial factors should Calla consider? Explain.
Analysis Component
3. Assume that the new customer wants to buy 15,000 units instead of 10,000 units—it will only buy 15,000 units or none and will not take a partial order. Without any computations, how does this change your answer for part 2?
Windmire Company manufactures and sells to local wholesalers approximately 300,000 units per month
at a sales price of \(4 per unit. Monthly costs for the production and sale of this quantity follow.
Direct materials . \)384,000
Direct labor 96,000
Overhead . 288,000
Selling expenses 120,000
Administrative expenses . 80,000
Total costs and expenses \(968,000
A new out-of-state distributor has offered to buy 50,000 units next month for \)3.44 each. These units
would be marketed in other states and would not affect Windmire’s sales through its normal channels. A
study of the costs of this new business reveals the following:
Direct materials costs are 100% variable.
Per unit direct labor costs for the additional units would be 50% higher than normal because their production
would require overtime pay at 1½ times their normal rate to meet the distributor’s deadline.
Twenty-five percent of the normal annual overhead costs are fixed at any production level from
250,000 to 400,000 units. The remaining 75% is variable with volume.
Accepting the new business would involve no additional selling expenses.
Accepting the new business would increase administrative expenses by a $4,000 fixed amount.
Required
Prepare a three-column comparative income statement that shows the following:
1. Monthly operating income without the special order (column 1).
2. Monthly operating income received from the new business only (column 2).
3. Combined monthly operating income from normal business and the new business (column 3).
Google has many types of costs. What is an out-of-pocket cost? What is an opportunity cost? Are opportunity costs recorded in the accounting records?
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