Question

Lessing Toy and Hobby (LTH) is a chain of hobby and craft stores in the Southeast. LTH operates multiple stores and is organized into two divisions: Northern and Southern. Individual stores are placed in one or the other division based on geography. Recent demographic changes in the Northern Division area have led to declining foot traffic and sales in the LTH stores. Senior corporate executives have been asking whether the chain should close those stores and focus on the stores in the Southern Division. The most recent income statement for the Northern Division follows.

Lessing Toy and Hobby
Northern Division
For the Year Ending January 31
($000)
Sales revenue $ 12,040
Costs
Cost of goods sold $ 6,020
Advertising 490
Administrative salaries 810
Sales commissions 1,624
Rent and occupancy expense 2,058
Allocated corporate support 1,330
Total costs $ 12,332
Net loss before tax benefit $ (292)
Tax benefit at 25% (73)
Net loss $ (219)
The CEO has asked for your thoughts on the decision to close the Northern Division stores. If the Northern Division is eliminated and the stores closed, neither total corporate support costs nor operations or costs of the Southern Division stores are expected to change.

Required:

Using the worksheet below, determine which revenues and costs are probably differential or not differential for the decision to close the Northern Division stores.
What will be the effect on LTH’s income if the Northern Division stores are closed?

Answer 1

Worksheet

Revenues or Costs: Differential?

Sales revenue Yes, eliminating the Northern Division stores would eliminate this revenue

Cost of goods sold No,this is a sunk cost that has already been incurred

Advertising Yes, advertising costs for the Northern Division stores would be eliminated

Administrative salaries Probably no, corporate administrative salaries would likely remain the same

Sales commissions Yes, sales commissions for the Northern Division stores would be eliminated

Rent and occupancy expense Yes, rent for the Northern Division stores would be eliminated

Allocated corporate support No, allocated corporate support costs are not expected to change if the Northern Division closes

If the Northern Division stores are closed, LTH's income would increase by at least $12,040,000 in sales revenue minus the differential costs that would be eliminated, such as advertising, sales commissions, and rent for those stores. The net impact would depend on the amount of the differential costs savings but would likely be a significant improvement to LTH's income.