Mini Case: Relevant Costs And Company Management Decisions

Minicase 7relevant Costsauls Companys Management Is Trying To Decide

Minicase 7 relevant costs sauls Companys Management Is Trying To Decide

Minicase 7 relevant costs sauls Companys Management is trying to decide whether to eliminate Department Z, which has produced low profits or losses for several years. The company's 2014 departmental income statement shows the following. Saul Company Departmental Income Statement For year ended December 31, 2014 Department A Department Z Combined Sales $350,000 $87,500 $437,500 Cost of goods sold 230,650 62,200 Gross profit 119,350 24,300 Operating expenses Advertising 13,500 1,500 15,000 Store supplies used 2,500 2,500 Depreciation – store 7,000 3,500 10,500 Total direct expense 23,300 5,700 29,000 Allocated expenses Sales salaries 35,100 11,700 46,800 Rent expense 11,040 2,760 13,800 Bad debts 10,500 2,000 12,500 Office salary 10,400 2,600 13,000 Insurance expense 2,800 2,800 Miscellaneous office expense 850 1,250 2,100 Total allocated expense 69,990 21,010 91,000 Total expenses 93,290 26,000 Net income 26,060 -1,300 In analyzing whether to eliminate Department Z, management considers the following items: a. The company has one office worker who earns $250 per week or $13,000 per year and four salesclerks who each earn $225 per week or $11,700 per year. 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.

Paper For Above instruction

Analysis of the Elimination of Department Z and Its Financial Impact on Saul Company

Saul Company faces a strategic decision regarding the elimination of Department Z, which has historically generated low or negative profits. The comprehensive financial data from 2014 provides a basis for a detailed analysis of the costs that would be eliminated versus those that would continue after the department’s removal. This analysis also involves considering whether reallocating resources and personnel could improve overall profitability, following the company's objectives to optimize operational efficiency.

Part 1: Preparing a three-column expense report

The first step involves segregating all expenses into three categories: total expenses, expenses eliminated by closing Department Z, and expenses that will continue. The total expenses comprise the sum of cost of goods sold (COGS), operating expenses, and allocated expenses. The expenses to be eliminated include direct costs tied directly to Department Z, such as sales salaries allocated to Z, advertising, bad debts, store supplies, and relevant portions of insurance and miscellaneous office expenses.

For example, the sales salaries charged fully to Department Z ($11,700 for one clerk) would be eliminated, while the part allocated to Department A would continue. Since the department’s closure will remove its advertising ($1,500), bad debts ($2,000), and store supplies ($2,500), these are included in the eliminated expenses. Additionally, a proportionate share of insurance (65%) and miscellaneous office expenses (30%) originally allocated to Department Z will also cease.

Part 2: Forecasted income statement considering department elimination

Assuming Department Z is eliminated, and its effect on Department A’s sales and gross profit is negligible, the company’s income statement can be adjusted accordingly. The key adjustment involves reallocating the office worker’s salary to sales by halving it from $13,000 to $6,500, reflecting the half-time sales role. The freed resources—such as the space and equipment—would be assumed to remain under Department A, given the long-term lease constraints.

The combined sales revenue would remain at $437,500, with Department A’s gross profit unaffected. The expense reductions would include all the costs associated with Department Z, including direct expenses and unallocated expenses previously assigned. The net income would be recalculated by subtracting the remaining expenses from total sales, resulting in a higher net income reflecting the cost savings.

This approach emphasizes focusing on cost control, reallocating personnel efficiently, and strategically removing or maintaining departments based on their contribution to the overall profitability. This financial and managerial analysis aids the company in making informed decisions that align with its cost management and operational strategies.

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