Question

Alberta Gauge Company, Ltd., a small manufacturing company in Calgary, Alberta, manufactures three types of electrical gauges used in a variety of machinery. For many years the company has been profitable and has operated at capacity. However, in the last two years, prices on all gauges were reduced and selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter results for the current year, which follow, typify recent experience.

  

ALBERTA GAUGE COMPANY, LTD.
Income Statement
Second Quarter
(in thousands)
	Q-Gauge					E-Gauge					R-Gauge					Total
Sales		$	6,624				$	4,368				$	4,092				$	15,084
Cost of goods sold			4,339					3,738					4,319					12,396
Gross margin		$	2,285				$	630				$	(227	)			$	2,688
Selling and administrative expenses			1,532					898					614					3,044
Income before taxes		$	753				$	(268	)			$	(841	)			$	(356	)

  

Alice Carlo, the company’s president, is concerned about the results of the pricing, selling, and production prices. After reviewing the second-quarter results, she asked her management staff to consider the following three suggestions:

• Discontinue the R-gauge line immediately. R-gauges would not be returned to the product line unless the problems with the gauge can be identified and resolved.
• Increase quarterly sales promotion by $420,000 on the Q-gauge product line in order to increase sales volume by 15 percent.
• Cut production on the E-gauge line by 50 percent, and cut the traceable advertising and promotion for this line to $120,000 each quarter.

Jason Sperry, the controller, suggested a more careful study of the financial relationships to determine the possible effects on the company’s operating results of the president’s proposed course of action. The president agreed and assigned JoAnn Brower, the assistant controller, to prepare an analysis. Brower has gathered the following information.

• All three gauges are manufactured with common equipment and facilities.
• The selling and administrative expense is allocated to the three gauge lines based on average sales volume over the past three years.
• Special selling expenses (primarily advertising, promotion, and shipping) are incurred for each gauge as follows:

	Quarterly Advertising and Promotion					Shipping Expenses
Q-gauge		$	750,000				$	42		per unit
E-gauge			420,000					24		per unit
R-gauge			240,000					90		per unit

• The unit manufacturing costs for the three products are as follows:

		Q-Gauge					E-Gauge					R-Gauge
Direct material		$	105.00				$	63.00				$	162.00
Direct labor			144.00					84.00					204.00
Variable manufacturing overhead			159.00					114.00					204.00
Fixed manufacturing overhead			63.63					72.75					126.61
Total		$	471.63				$	333.75				$	696.61

• The unit sales prices for the three products are as follows:

Q-gauge	$	720
E-gauge		390
R-gauge		660

• The company is manufacturing at capacity and is selling all the gauges it produces.

Required:

1. 2. Use the operating data presented for Alberta Gauge Company and assume that the president’s proposed course of action had been implemented at the beginning of the second quarter.

2. a. Calculate the net impact on income before taxes for each of the three suggestions.

3. b-1. Calculate contribution margin for R-gauge

4. b-2. Was the president correct in proposing that the R-gauge line be eliminated?

5. c-1. Calculate the contribution per direct-labor dollar for Q-gauge and E-gauge.

6. c-2. Was the president correct in promoting the Q-gauge line rather than the E-gauge line?

Answer 1