|Original Order||Alternative 1 – Selling the Equipment to Ray Corporation||Alternative 2 – Convert the Equipment||Alternative 3 – Sell the Machine as is|
|Deposit ( Other Income )||80,000||80,000||80,000||80,000|
|Cost of the Manufactured Machine|
|Fixed Over Head||62,500||77,500||67,500||62,500|
|Fixed Administration Costs||58,875||74,250||68,750||58,875|
|Special Orders Commissions 2%||0||13,600||0||0|
|Standard Models Commissions 1%||0||0||6450||0|
|Net income (loss)||217,625||-70,350||-50,600||-16,375|
In this given situation, East Company has to select one out of three given alternatives for selling its equipment. The first option is to sell the equipment after specific reworking, the second option is to convert the equipment to a standard model and sell it and the last option is to sell it without any further processing.
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First of all, it is assumed that the deposit received by the company is non-refundable which allows us to treat it as other income. Now before examining the relevant information related to the available choices, it is important to know that the cost already incurred on the equipment is irrelevant in reaching our decision, thus the incremental costs for each option shall be considered. Although the first two options offer a higher selling price than the third one, as it is assumed in accounting that there is a linear relationship between revenue and cost, they both require additional conversion costs and overhead costs. Moreover, other expenses like a commission paid and discount offered are also forming part of the incremental cost. After computing the total cost of the first two options it can be seen that the total cost is more than the selling price thus showing a net loss. On the other hand, the third option does not require any additional costs but at the same time offers a comparatively low selling price which is insufficient to cover up the costs on the equipment which has already been incurred.
It is, therefore, concluded that all three options show a net loss. Among all three available alternatives, the third one shows the lowest amount of loss and thus, it is recommended that the East Company shall sell the equipment as is without making any changes to the equipment and incurring additional costs.
|West Dept.||East Dept.||Combined||Total Company Expenses (Existing – Without the Elimination)||Expenses would be Eliminated by Closing the East Department ( Saving )||The Expense that will continue (the new West Dept Income Statement )|
|Cost of goods sold||534,000||414,000||948,000||948,000||0||534,000|
|Other Income (Leased Equipment)||0||0||0||0||0||80,000|
|Store Supplies Used||9,000||7,600||16,600||16,600||7,600||9,000|
|Total direct expenses||55,000||38,200||93,200||93,200||31,600||61,600|
|Bad Debts Expense||19,800||16,200||36,000||36,000||16,200||19,800|
|Miscellaneous office expenses||4,800||3,200||8,000||8,000||1,600||1,600|
|Total allocated expenses||334,920||206,000||540,920||540,920||194,080||288,040|
|Net income (loss)||48,080||-78,200||-30,120||-30,120||0||168,360|
In this scenario, the General Manager of Hall Company has asked to evaluate whether to eliminate the east department. Since it is assumed that the elimination of East department will not have any effect on the sales and gross profit of the West department, therefore, only expenses need to be analyzed.
As per given information, if the company decides to shut down East it can avoid expenses like sales salaries, office salaries, advertising, bad debts, and supplies expenses, whereas insurance and miscellaneous expenses can be reduced from 50% to 60% of the current amounts respectively, and the remainder will be transferred to West department. On the other hand, sales and office salaries expense will have to be adjusted as half of the office salaries expense is to be charged to the sales salaries expense. After making all these adjustments have been made it is important to note that the total expenses that will continue to incur after eliminating East department are less than the total expenses that West department is incurring at present and the reason is a reduction of 20 % in the sales salaries.
Upon elimination of the East department the company has an option to increase its revenue by leasing the equipment left to others which will increase its net income considerably. If the company does not shut down the department it will continue to report an overall loss, whereas, the change will result in a more profitable West department as compared to its current position. Therefore, it is viable for the Hall Company to go for the downsizing of its business because the level of profitability will be much higher than at present.