Prior to last year, Leastan Company had not kept departmental income statements.

Question:

Department closing. Prior to last year, Leastan Company had not kept departmental income statements. To achieve better management control, the company decided to install department-by-department accounts. At the end of last year, the new accounts showed that although the business as a whole was profitable, the Dry Goods Department had shown a substantial loss. The income statement for the Dry Goods Department, shown here, reports on operations for last year.

Analysis of these results has led management to suggest that it close the Dry Goods Department. Members of the management team agree that keeping the Dry Goods Department is not essential to maintaining good customer relations and supporting the rest of the company’s business. In other words, eliminating the Dry Goods Department is not expected to affect the amount of business done by the other departments.

What action do you recommend to management of Leastan Company in the short run? Why?

Answer:

Apparently, the payroll or direct labor costs also protected, but we can’t be so certain for supervision costs. Narrowing down that might not save all costs, since we might not able to relieve a supervisor.

Commission$15,000
State Taxes$1,500
Insurance$2,000
Interest$2,500
Operating Costs$21,000

Obviously, the rent does not fall and much of the administrative and office costs will remain as before. Devaluation of the equipment does not essentially continue since the company can discard off the equipment. There might be few cash receipts from equipment discarding. At any rate, the devaluation is not cash expenditure.

Gross Margin$62,500
Differential Operating Costs$(21,000)
Pay$(16,500)
Contribution$25,000

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