Question

Vortex Company operates a retail store with two departments. Information about those departments follows.

	Department A	Department B
Sales	\(800,000	\)450,000
Cost of goods sold	497,000	291,000
Direct expenses
Salaries	125,000	88,000
Insurance	20,000	10,000
Utilities	24,000	14,000
Depreciation	21,000	12,000
Maintenance	7,000	5,000

The company also incurred the following indirect costs.

Salaries	$36,000
Insurance	6,000
Depreciation	15,000
Office expenses	50,000

Indirect costs are allocated as follows: salaries on the basis of sales; insurance and depreciation on the basis of square footage; and office expenses on the basis of number of employees. Additional information about the departments follows.

Department	Square footage	Number of employees
A	28,000	75
B	12,000	50

Required

1. For each department, determine the departmental contribution to overhead and the departmental net income.

2. Should Department B be eliminated? Explain

Short answer

Net income of department A: $38,260.

Net income of department B:($9,260).

No, Department B must not be eliminated.

Step-by-step solution

Definition of Overheads

The business expenses that are not directly associated with the production process are known as overheads. Even though these expenses are not directly related to production, they are included in the preparation of the budgets.

Departmental income statement

	Department A	Department B
Sales	$800,000	$450,000
Cost of goods sold	497,000	291,000
Gross profit	303,000	159,000
Direct expenses
Salaries	125,000	88,000
Insurance	20,000	10,000
Utilities	24,000	14,000
Depreciation	21,000	12,000
Maintenance	7,000	5,000
Total direct expenses	197,000	129,000
Departmental contribution to overhead	106,000	30,000
Indirect costs:
Salaries	23,040	12,960
Insurance	4,200	1,800
Depreciation	10,500	4,500
Office expenses	30,000	20,000
Total indirect expenses	67,740	39,260
Departmental net income	$38,260	($9,260)

Elimination of department B

The business entity must not eliminate department B because it generates a contribution of $30,000 for overheads. The business entity can reduce some of its indirect expenses to reduce the loss occurring from department B.