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 $ 8,600,000
Costs
Advertising—City Division 350,000
Cost of goods sold 4,300,000
Divisional administrative salaries 580,000
Selling costs (sales commissions) 1,160,000
Rent 1,470,000
Share of corporate administration 950,000
Total costs $ 8,810,000
Net loss before income tax benefit $ (210,000 )
Tax benefit at 40% rate 84,000
Net loss $ (126,000 )
Required:

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

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

Betsy's profits wil_______________(Increase or Decrease) by what_________?

Answer 1

To discontinue the City Division's operations, the differential revenues are the sales revenue of $8,600,000, and the differential costs are the advertising cost, City Division administrative salaries, selling costs, and rent cost. If the division is eliminated, Betty's profits will increase by $126,000.

Step-by-step explanation:

To determine which revenues and costs are differential for the decision to discontinue City Division's operations, we need to identify the costs and revenues that would change if the division is eliminated. Differential revenues are those that are unique to the City Division and will no longer be generated if it is shut down. In this case, the sales revenue of $8,600,000 is a differential revenue. Differential costs are those costs that are specific to the City Division and would no longer be incurred if it is shut down. In this case, the advertising cost of $350,000, the City Division administrative salaries of $580,000, the selling costs of $1,160,000, and the rent cost of $1,470,000 are all differential costs.

If the City Division is eliminated, Betty's profits will increase by $(210,000 - 84,000) = $126,000. This is because the City Division is currently operating at a net loss of $(126,000) before income tax benefit. By shutting down the division, the company would no longer incur the loss, resulting in a net increase in profits.

Answer 2

Intructions are listed below

Step-by-step explanation:

A) To calculate the differential cost and revenues we need to determine which ones will maintain whether the City's division closes.

Not differential:

Share of corporate administration 950,000

Differential:

Sales revenue $ 8,600,000

Costs

Advertising—City Division 350,000

Cost of goods sold 4,300,000

Divisional administrative salaries 580,000

Selling costs (sales commissions) 1,160,000

Rent 1,470,000

B) Betty's profit will increase in the amount of saving the net loss minus the tax saving.

Betty's profit will increase by $126000