Betty's Fashions operates retail stores in both downtown and suburban locations. The company has...

Question:

Betty's Fashions operates retail stores in both downtown and suburban locations. The company has two responsibility centers: the City Division, which contains stores in downtown locations, and the Mall Division, which contains stores in suburban locations. Betty's CEO is concerned about the profitability of the City Division, which has been operating at a loss for the last several years. The most recent City Division income statement follows. The CEO has asked for your advice on shutting down the City Division's operations. If the City Division is eliminated, corporate administration is not expected to change, nor are any other changes expected in the operations or costs of the Mall Division.

BETTY'S FASHIONS, CITY DIVISION
Divisional Income Statement
For the Year Ending January 31
Sales revenue $ 5,200,000
Cost
Advertising-City Division 184,000
Cost of goods sold 3,050,000
Divisional administrative salaries 299,000
Selling costs (sales commissions) 589,000
Rent 744,000
Share of corporate administration 484,000
Total costs $5,350,000
Net loss before income tax benefit $(150,000)
Tax benefit at 40% rate 60,000
Net loss $(90,000)

Required:

a. Using the worksheet below, determine which revenues and costs are probably differentials for the decision to discontinue City Division's operations.

Betty's Fashions, City Division
Divisional Income Statement
Differential Revenues and Costs
For the Year Ending January 31
Sales revenue $ 5,200,000
Cost
Advertising-City Division 184,000
Cost of goods sold 3,050,000
Divisional administrative salaries 299,000
Selling costs (sales commissions) 589,000
Rent 744,000
Share of corporate administration 484,000
Total costs $5,350,000
Net loss before income tax benefit $(150,000)
Tax benefit at 40% rate 60,000
Net loss $(90,000)

b. What will be the effect on Betty?s profits if the division is eliminated?

Differential Costing

Differential costs examine the difference in costs between various options that a company is contemplating to pursue. It is an important concept in relevant costing when an organization is seeking to eliminate a product or segment. Differential costs are relevant costs as these costs are will differ when an organization decides whether or not to eliminate a product or segment. The aim of differential costing is to calculate the profitability of each alternative and pursue the alternative that yields the greatest benefit.

Answer and Explanation:

Betty's Fashions, City Division| |

Divisional Income Statement
Differential Revenues and Costs
For the Year Ending January 31
Sales revenue $ 5,200,000 Differential
Cost
Advertising-City Division 184,000 Differential
Cost of goods sold 3,050,000 Differential
Divisional administrative salaries 299,000 Differential
Selling costs (sales commissions) 589,000 Differential
Rent 744,000 Differential
Share of corporate administration 484,000 Non-Differential
Total costs $5,350,000
Net loss before income tax benefit $(150,000)
Tax benefit at 40% rate 60,000 Differential
Net loss $(90,000)

b.

Effect on Betty?s profits:

Sales revenue 5,200,000
Less
Advertising-City Division 184,000
Cost of goods sold 3,050,000
Divisional administrative salaries 299,000
Selling costs (sales commissions) 589,000
Rent 744,000
Attributable Profit before tax 334,000
Tax at 40% rate 133,600
Attributable Profit after tax 200,400

If the Division is eliminated, Betty?s profit will decrease by $200,400.


Learn more about this topic:

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Relevant Costs in Eliminating a Product or Segment

from Accounting 301: Applied Managerial Accounting

Chapter 9 / Lesson 12
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