Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 54

Decision Whether to Close a Store

Power Music owns five music stores, where it sells music, instruments, and supplies. In addition, it rents instruments. At the end of last year, the new accounts showed that although the business as a whole was profitable, the Fifth Avenue store had shown a substantial loss. The income statement for the Fifth Avenue store for last month follows:

POWER MUSIC Fifth Avenue Store Partial Income Statement
Sales			$650,000
Cost of goods sold			560,000
Gross margin			$ 90,000
Costs:
Payroll, direct labor, and supervisiona		$ 51,000
Rentb		16,100
State taxesc		2,500
Insurance on inventory		18,400
Depreciationd		7,500
Administration and general officee		20,000
Interest for inventory carrying costsf		4,500
Total costs			120,000
Loss			$ (30,000)

Additional computations:

a These costs would be saved if the store was closed.

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b The rent would be saved if the store was closed.

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c Assessed annually on the basis of average inventory on hand each month.

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d 8.5 percent of cost of departmental equipment. The equipment has no salvage value, and Power Music would incur no costs in scrapping it.

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e Allocated on the basis of store sales as a fraction of total company sales. Management estimates that 10% of these costs allocated to the Fifth Avenue store could be saved if the store was closed.

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f Based on average inventory quantity multiplied by the company’s borrowing rate for three- month loans.

Analysis of these results has led management to consider closing the Fifth Avenue store. Members of the management team agree that keeping the Fifth Avenue store open is not essential to maintaining good customer relations and supporting the rest of the company’s business. In other words, eliminating the Fifth Avenue store is not expected to affect the amount of business done by the other stores.

Required

What action do you recommend to Power Music’s management? Write a short report to management recommending whether or not to close the Fifth Avenue store. Include the reasons for your recommendation.