Walsh company manufactures and sells one product

Toxaway Company is a merchandiser that segments its business into two divisions—Commercial and Residential. The company’s accounting intern was asked to prepare segmented income statements that the company’s divisional managers could use to calculate their break-even points and make decisions. She took the prior month’s companywide income statement and prepared the absorption format segmented income statement shown below:

Total
Company

Commercial

Residential

Sales

$

960,000

$

320,000

$

640,000

Cost of goods sold

636,800

169,600

467,200

Gross margin

323,200

150,400

172,800

Selling and administrative expenses

296,000

132,000

164,000

Net operating income

$

27,200

$

18,400

$

8,800

In preparing these statements, the intern determined that Toxaway’s only variable selling and administrative expense is a 10% sales commission on all sales. The company’s total fixed expenses include $66,000 of common fixed expenses that would continue to be incurred even if the Commercial or Residential segments are discontinued, $78,000 of fixed expenses that would be avoided if the Commericial segment is dropped, and $56,000 of fixed expenses that would be avoided if the Residential segment is dropped.

Required:

1. Do you agree with the intern’s decision to use an absorption format for her segmented income statement?

2. Based on a review of the intern’s segmented income statement.

a. How much of the company’s common fixed expenses did she allocate to the Commercial and Residential segments?

b. Which of the following three allocation bases did she most likely used to allocate common fixed expenses to the Commercial and Residential segments: (a) sales, (b) cost of goods sold, or (c) gross margin?

3. Do you agree with the intern’s decision to allocate the common fixed expenses to the Commercial and Residential segments?