Question

Diego Company manufactures one product that is sold for $76 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 47,000 units and sold 42,000 units.

Variable costs per unit:
Manufacturing:
Direct materials	$	26
Direct labor	$	10
Variable manufacturing overhead	$	2
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	987,000
Fixed selling and administrative expense	$	475,000

The company sold 32,000 units in the East region and 10,000 units in the West region. It determined that $210,000 of its fixed selling and administrative expense is traceable to the West region, $160,000 is traceable to the East region, and the remaining $105,000 is a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.

1. What is the company’s total gross margin under absorption costing? What is the amount of the difference between the variable costing and absorption costing net operating incomes (losses)?

2. If the sales volumes in the East and West regions had been reversed, what would be the company’s overall break-even point in unit sales? What would have been the company’s variable costing net operating income (loss) if it had produced and sold 42,000 units? You do not need to perform any calculations to answer this question.

3.  Prepare a contribution format segmented income statement that includes a Total column and columns for the East and West regions.

4. Assume the West region invests $37,000 in a new advertising campaign in Year 2 that increases its unit sales by 20%. If all else remains constant, what would be the profit impact of pursuing the advertising campaign?

Answer 1

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Ans 1					Ans 2
Variable costing statement	East	West	Total		If Sales Reversed	Total
Sell Price	76.00	76.00	76.00	A	Fixed manufacturing overhead	987,000.00	J
Direct Materials	26.00	26.00	26.00	B	Fixed selling and admin	475,000.00	K
Direct Labor	10.00	10.00	10.00	C	Total Fixed costs	1,462,000.00	U=J+K
Variable manufacturing overhead	2.00	2.00	2.00	D	Contribution per unit	34.00	G
Variable selling and admin	4.00	4.00	4.00	E	Break-even point in unit sales	43,000.00	V=U/G
Total Variable cost	42.00	42.00	42.00	F=B+C+D+E
Contribution per unit	34.00	34.00	34.00	G=A-F	If 42,000 units sold	Total
Number of units sold	32,000.00	10,000.00	42,000.00	H	Break-even point in unit sales	43,000.00	V
Contribution amount	1,088,000.00	340,000.00	1,428,000.00	I=G*H	Number of units sold	42,000.00	W
Fixed manufacturing overhead			987,000.00	J	Contribution per unit	34.00	G
Fixed selling and admin			475,000.00	K	Contribution lost	34,000.00	X=(V-W)*G
Net operating Income / (Loss)			(34,000.00)	L=I-J-K	Net operating Income / (Loss)	(34,000.00)	X
Absorption costing statement	East	West	Total		Ans 3
Fixed manufacturing overhead			987,000.00	J	Prepare a contribution format segmented income statement that includes a Total column and columns for the East and West regions.
Number of units produced			47,000.00	M	Same as Variable costing statement of Ans 1
Fixed manufacturing overhead per unit			21.00	N=J/M
					Ans 4
Sell Price	76.00	76.00	76.00	A	If advertising campaign:	West
Direct Materials	26.00	26.00	26.00	B	Contribution per unit	34.00	G
Direct Labor	10.00	10.00	10.00	C	Number of extra units sold (10000*20%)	2,000.00	Y=10000*20%
Variable manufacturing overhead	2.00	2.00	2.00	D	Contribution amount	68,000.00	Z=G*Y
Fixed manufacturing overhead	21.00	21.00	21.00	N	Advertising cost	37,000.00	AA
Cost of goods sold	59.00	59.00	59.00	P=B+C+D+N	Incremental operating Income / (Loss)	31,000.00	AB=Z-AA
Variable selling and admin	4.00	4.00	4.00	E	If additional advertising cost is incurred by West Division then loss will decrease by $ 31,000.
Cost of sales	63.00	63.00	63.00	Q=P+E
Number of units sold	32,000.00	10,000.00	42,000.00	H
Total sales	2,432,000.00	760,000.00	3,192,000.00	O=H*A
Cost of sales	2,016,000.00	630,000.00	2,646,000.00	R=Q*H
Fixed selling and admin			475,000.00	K
Net operating Income / (Loss)			71,000.00	S=O-R-K
Difference			105,000.00	T=S-L
The difference between the variable costing and absorption costing net operating income/ (loss) is $ 105,000.