Question

1. Devern Assurance Company provides both property and automobile insurance. The projected income statements for the two products are as follows:

   	Property Insurance		Automobile Insurance
   Sales	$4,200,000		$12,000,000
   Less variable expenses	3,830,000		9,600,000
   Contribution margin	$370,000		$2,400,000
   Less direct fixed expenses	400,000		500,000
   Segment margin	$(30,000)		$1,900,000
   Less common fixed expenses (allocated)	100,000		200,000
   Operating income (loss)	$(130,000)		$1,700,000

   The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

   Required:

   1. If Devern Assurance Company drops property insurance, by how much will income increase or decrease?

     by $

   As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

   Devern Assurance Company
   Keep-or-Drop For Service Firm
   Segmented Income Statement
   	Keep	Drop
   	$	$
   	$	$
   	$	$

   2. Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.

   Devern Assurance Company
   Keep-or-Drop For Service Firm
   Segmented Income Statement
   	Property Insurance	Automobile Insurance	Total
   	$	$	$
   	$	$	$
   	$	$	$
   			$

Answer 1

	KEEP	DROP
SALES	16,200,000	10,560,000
VARIABLE EXPENSES	(13,430,000)	(8,448,000)
CONTRIBUTION MARGIN	2,770,000	2,112,000
DIRECT FIXED EXPENSES	(900,000)	(500,000)
SEGMENT MARGIN	1,870,000	1,612,000
COMMON FIXED EXPENSES	(300,000)	(200,000)
OPERATING INCOME	1,570,000	1,412,000

The figures in the keep column are cumulative of both the segments. The variable expenses in the drop column will decrease by 12% whereas the fixed expenses will remain the same.

As the table above shows, if the company drops the property insurance segment, the operating income will fall by 158,000.

PART 2.

	PROPERTY	AUTOMOBILE	TOTAL
SALES	4,620,000	12,960,000	17,580,000
VARIABLE EXPENSES	(4,213,000)	(10,368,000)	(14,581,000)
CONTRIBUTION MARGIN	407,000	2,592,000	2,999,000
DIRECT FIXED EXPENSES	(400,000)	(500,000)	(900,000)
SEGMENT MARGIN	7,000	2,092,000	2,099,000
COMMON FIXED EXPENSES	(100,000)	(200,000)	(300,000)
ADVERTISING BUDGET			(450,000)
OPERATING INCOME	(93,000)	1.892.000	1,349,000

After the increase in the advertising budget, the overall operating income (after factoring in the cost associated with the increase) will fall from 1,570,000 to 1,349,000.