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.
