As per the given information, the Vortex company has two departments has tends to operate a retail store. For each department, details have been provided with regards to the underlying revenue and direct expenses. Further, for the company as a whole, the indirect expenses are also provided. The central objective is to allocate the indirect expenses to the two departments in accordance with the respective basis and thereby decide whether a particular department should be eliminated on account of profitability concerns.
Allocation of Salaries
Total indirect expenses as salaries = $ 36,000
This needs to be allocated to the two departments A and B on the basis of the underlying sales.
Based on the given information, it is known that sales of department A = $800,000 while sales of department B = $ 450,000
Ratio of sales of Department A: Department B = 80:45 = 16:9
Hence, salary expenses allocated to department A = (16/(16+9))*36000 = $ 23,040
Further, salary expenses allocated to department B = (9/(16+9))*36000 = $ 12,960
Allocation of Insurance
Total indirect expenses as insurance = $ 6,000
This needs to be allocated to the two departments A and B on the basis of the square footage area.
Based on the given information, it is known that square footage of department A = 28,000 while square footage of department B = 12,000
Ratio of square footage of Department A: Department B = 28:12 = 7:3
Hence, insurance expenses allocated to department A = (7/(7+3))*6000 = $ 4,200
Further, insurance expenses allocated to department B = (3/(7+3))*6000 = $ 1,800
Allocation of Depreciation
Total indirect expenses as depreciation= $ 15,000
This needs to be allocated to the two departments A and B on the basis of the square footage area.
Based on the given information, it is known that square footage of department A = 28,000 while square footage of department B = 12,000
Ratio of square footage of Department A: Department B = 28:12 = 7:3
Hence, depreciation expenses allocated to department A = (7/(7+3))*15000 = $ 10,500
Further, depreciation expenses allocated to department B = (3/(7+3))*15000 = $ 4,500
Allocation of office expenses
Total indirect expenses as office expenses = $ 50,000
This needs to be allocated to the two departments A and B on the basis of the number of employees
Based on the given information, it is known that number of employees in department A = 75 while number of employees in department B = 50
Ratio of number of employees of Department A: Department B = 75:50= 3:2
Hence, office expenses allocated to department A = (3/(3+2))*50000 = $ 30,000
Further, expenses allocated to department B = (2/(3+2))*50000 = $ 20,000
Departmental Contribution to Overhead
On the basis of the above allocation of various indirect overhead cost to the two departments A and B, the following overhead cost distribution may be obtained (Bhimani et. al., 2017).
|
Particulars |
Department A |
Department B |
|
Salaries |
23040 |
12960 |
|
Insurance |
4200 |
1800 |
|
Depreciation |
10500 |
4500 |
|
Office Expenses |
30000 |
20000 |
|
Total Overhead Costs ($) |
67740 |
39260 |
Hence, from the above computation, it may be concluded that the overhead costs allocated to department A is $ 67,740 while the overhead costs allocated to department B is $ 39,260.
The computation of the net departmental income is indicated as shown below. Besides, the direct expenses, it also includes the indirect expenses so that the net income for each of the two departments may be accurately determined. With this intention, the allocation of the overhead costs to the two departments was carried out. The requisite income statement for the two departments is shown below (Damodaran, 2015).
|
Particulars |
Department A |
Department B |
|
Sales |
800000 |
450000 |
|
Cost of Goods Sold |
497000 |
291000 |
|
Direct Expenses |
||
|
Salaries |
125000 |
88000 |
|
Insurance |
20000 |
10000 |
|
Utilities |
24000 |
14000 |
|
Depreciation |
21000 |
12000 |
|
Maintenance |
7000 |
5000 |
|
Indirect Expenses |
|
|
|
Salaries |
23040 |
12960 |
|
Insurance |
4200 |
1800 |
|
Depreciation |
10500 |
4500 |
|
Office Expenses |
30000 |
20000 |
|
Net income |
38260 |
-9260 |
From the above computations, the net income for Department A is $ 38,260 while the net income for Department B is -$ 9,260. This implies that department A makes a profit while department B is making a net loss.
Problem 10-6A
Case a: Company’s total expenses which include the cost of goods sold
Case b: The expenses which would be eliminated by closing the department 200
Case c: The expenses which would be continued
Eliminated expenses are set of expenses which are eliminated in regards to the closure of the respective department. Cost of goods sold, store supplies, sales, bad debt expenses. Miscellaneous office expenses, Advertisement expenses, insurance expenses are some of key example of elimination expenses. While the continuing expenses are those which would be continued even though there is closure of the department. Sales salaries, other office salary are continuing expenses (Emmauel & Otley, 2015).
It is apparent from the case facts that closing department 200 has eliminated 70% of insurance expenses (eliminating expenses) and also, 25% of their miscellaneous office expenses (eliminating expenses). Due to this elimination, the sales salaries would also be reduced as any amount which has been paid to the two clerks would not be replaced. Further, the office salary would not be the part of elimination. However, it is essential to note that the reclassification of the sales would be done which indicates that one-half would be reported as the company’s sales and the rest one-half would be reported as office salary (Heisinger, 2014).
The three columns report is shown below.
It is noteworthy that income statement is an essential financial statement as it represents that various business transactions which have been done over a defined period of time generally monthly or yearly basis. The general format of an income statement comprises the deduction of total expenses from the total revenues. The case when the total revenue is higher than the total expenses of the company in definite time then the company would get a net income. While, when the net revenue of the company is lower than the total expenses then the company would suffer a net loss (Kane & Marcus, 2013). The income statement of the company is shown below (Northington, 2015).
The revised salaries are computed based on the salary of the sales clerk, administrative worker for the reallocation of the workers to the sales department. The calculation of the revised salaries is highlighted below (Lasher, 2017).
In this case, the combined net income would be reconciled to the forecasted net income through eliminating the lost sales on Department 200 and accumulating the eliminating expenses which has been incurred on Department 200. The table to represent the Reconciliation of the net income with the forecasted net income is highlighted below (Damodaran, 2015).
Based on the above shown table, it can be concluded that there is significant avoidable expenses of total worth $284,00 of department 200. This amount is $5930 lower than the revenue amount which is $290,000. It indicates that annual net income of the company would be $5930 lower from eliminating department 200. Hence, it has been suggested that department should not do elimination (Ehrhardt & Brigham, 2016).
References
Bhimani, A., Horngren, C.T., Datar, S.M. & Foster, G. (2017), Management and Cost Accounting 4th ed. Harlow: Prentice Hall/Financial Times
Brealey, R. A., Myers, S. C. & Allen, F. (2014) Principles of corporate finance, 6th ed. New York: McGraw-Hill Publications
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York: Cengage Learning
Ehrhardt, M. C. & Brigham, E. F. (2016) Corporate Finance: A Focused Approach. 6th ed. London: South- Western College Publisher
Emmauel, R.C. & Otley, T.D. (2015) Accounting for Management Control. 8th ed. London: Cengage Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.
Kane, B.Z. and Marcus, A.J. (2013) Essentials of Investment, 9th ed, Singapore: McGraw-Hill International
Lasher, W. R., (2017) Practical Financial Management 5th ed. London: South- Western College Publisher.
Northington, S. (2015) Finance, 4th ed. New York: Ferguson
Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M. & Nguyen, H. (2015). Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French Forest Australia
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