Diversified Products, Inc., has recently acquired a small publishing company tha
ID: 2590517 • Letter: D
Question
Diversified Products, Inc., has recently acquired a small publishing company that offers three books for sale—a cookbook, a travel guide, and a handy speller. Each book sells for $10. The publishing company’s most recent monthly income statement is shown below.
Product line
The following additional information is available:
Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the income statement above. Sales commissions are 10% of sales.
The same equipment is used to produce all three books, so the equipment depreciation cost has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 35% of the time to produce cookbooks, 55% of the time to produce travel guides, and 10% of the time to produce handy spellers.
The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is $3 per square foot per year. The warehouse contains 55,200 square feet of space, of which 10,000 square feet is used by the cookbook line, 26,800 square feet by the travel guide line, and 18,400 square feet by the handy speller line.
The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars.
The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines.
All other costs are traceable to the three product lines in the amounts shown on the income statement above.
The management of Diversified Products, Inc., is anxious to improve the publishing company’s 5% return on sales.
Required:
1. Prepare a new contribution format segmented income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional information provided.
2. Based on the segmented income statements given in the problem, management plans to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide. However, based on the new contribution format segmented income statement that you prepared:
a. Do you agree with management's plan to eliminate the cookbook?
b-1. Compute the contribution margin ratio for each product.
b-2. Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide?
Product line
TotalCompany Cookbook Travel
Guide Handy
Speller Sales $ 345,000 $ 116,000 $ 164,000 $ 65,000 Expenses: Printing costs 116,000 41,000 64,400 10,600 Advertising 36,000 16,000 16,500 3,500 General sales 20,700 6,960 9,840 3,900 Salaries 31,000 16,000 10,400 4,600 Equipment depreciation 9,900 3,300 3,300 3,300 Sales commissions 34,500 11,600 16,400 6,500 General administration 46,200 15,400 15,400 15,400 Warehouse rent 13,800 4,640 6,560 2,600 Depreciation—office facilities 7,200 2,400 2,400 2,400 Total expenses 315,300 117,300 145,200 52,800 Net operating income (loss) $ 29,700 $ (1,300 ) $ 18,800 $ 12,200
Explanation / Answer
Answer:
1
Total
Travel
Handy
Company
Cook
book
Guide
Speller
Sales(a)
345000
116000
164000
65000
Less: variable cost
Printing costs
116000
41000
64400
10600
Sales commissions
34500
11600
16400
6500
Total variable cost (b)
150500
52600
80800
17100
Contribution margin (a-b)
194500
63400
83200
47900
Tracable Fixed cost
Advertising
36000
16000
16500
3500
Salaries
31000
16000
10400
4600
Equipment depreciation
(35:55:10)
9900
3465
5445
990
Warehouse rent
(10,000:26800:18400)
13800
2500
6700
4600
Total tracable cost
90700
37965
39045
13690
Segment margin
103800
25435
44155
34210
Less: common Fixed cost
Depreciation—office facilities
7200
General sales
20700
General administration
46200
Total common Fixed cost
74100
Net operating income (loss)
29700
2
Do you agree with management's plan to eliminate the cookbook?
Answer: NO
As segment margin is positive so management's should not eliminate the cookbook
_______________________________________________________
b-1. Compute the contribution margin ratio for each product.
Cook
book
Travel
Guide
Handy
Speller
Sales(a)
116000
164000
65000
Contribution margin (b)
63400
83200
47900
Contribution margin ratio
54.66%
50.73%
73.69%
______________________________
b-2. Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide?
Answer: NO
Total
Travel
Handy
Company
Cook
book
Guide
Speller
Sales(a)
345000
116000
164000
65000
Less: variable cost
Printing costs
116000
41000
64400
10600
Sales commissions
34500
11600
16400
6500
Total variable cost (b)
150500
52600
80800
17100
Contribution margin (a-b)
194500
63400
83200
47900
Tracable Fixed cost
Advertising
36000
16000
16500
3500
Salaries
31000
16000
10400
4600
Equipment depreciation
(35:55:10)
9900
3465
5445
990
Warehouse rent
(10,000:26800:18400)
13800
2500
6700
4600
Total tracable cost
90700
37965
39045
13690
Segment margin
103800
25435
44155
34210
Less: common Fixed cost
Depreciation—office facilities
7200
General sales
20700
General administration
46200
Total common Fixed cost
74100
Net operating income (loss)
29700