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 58,000 units and sold 54,000 units.

  

Variable costs per unit:
Manufacturing:
Direct materials	$	23
Direct labor	$	15
Variable manufacturing overhead	$	3
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	1,160,000
Fixed selling and administrative expenses	$	640,000

  

The company sold 40,000 units in the East region and 14,000 units in the West region. It determined that $320,000 of its fixed selling and administrative expenses is traceable to the West region, $270,000 is traceable to the East region, and the remaining $50,000 is a common fixed cost. 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. Prepare a contribution format segmented income statement that includes a Total column and columns for the East and West regions. Diego is considering eliminating the West region because an internally generated report suggests the region’s total gross margin in the first year of operations was $110,000 less than its traceable fixed selling and administrative expenses. Diego believes that if it drops the West region, the East region's sales will grow by 4% in Year 2. Using the contribution approach for analyzing segment profitability and assuming all else remains constant in Year 2, what would be the profit impact of dropping the West region in Year 2? Assume the West region invests $48,000 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

Diego Company				Segments
Income Statement by Divisions
For the Year Ended-1
	Diego Company			East Regions			West Regions
	Dollars		%	Dollars		%	Dollars		%
Sales	4,104,000		100%	3,040,000		100%	1,064,000		100%
Variable Cost
Direct Material	1,242,000		30%	920,000		30%	322,000		30%
Direct Labor	810,000		20%	600,000		20%	210,000		20%
Variable Manufacturing Overheads	162,000		4%	120,000		4%	42,000		4%
Variable SG&A	162,000		4%	120,000		4%	42,000		4%
Contribution Margin	1,728,000		42%	1,280,000		42%	448,000		42%
Traceable Fixed Cost
Fixed Manufacturing Overheads(Allocated on sales basis)	1,160,000		28%	859,259		21%	300,741		7%
Fixed SG&A	590,000		14%	270,000		7%	320,000		8%
Contribution to Common fixed Cost	-22,000		-1%	150,741		5%	-172,741		-16%
Common Fixed Cost	50,000		1%
Net Operating Income	-72,000		-2%
If West Regions closed in year 2-Sale of 41600 units in East region
Diego Company				Segments
Projected Income Statement by Divisions
For the Year Ended 2
	Diego Company			East Regions			West Regions
	Dollars		%	Dollars		%	Dollars		%
Sales	3,161,600		100%	3,161,600		100%			0%
Variable Cost
Direct Material	956,800		30%	956,800		30%			0%
Direct Labor	624,000		20%	624,000		20%			0%
Variable Manufacturing Overheads	124,800		4%	124,800		4%			0%
Variable SG&A	124,800		4%	124,800		4%			0%
Contribution Margin	1,331,200		42%	1,331,200		42%	-		0%
Traceable Fixed Cost
Fixed Manufacturing Overheads(Allocated on sales basis)	1,160,000		37%	1,160,000		37%	-		0%
Fixed SG&A	270,000		9%	270,000		9%			0%
Contribution to Common fixed Cost	-98,800		-3%	-98,800		-3%	-		0%
Common Fixed Cost	50,000		2%
Net Operating Income	-148,800		-5%
Decision : If close the west regionin year 2 the loss will increase to $148,800
Loss will increase by $76,800
If Additional Investment in advertising in west region (SALES OF 16,200 UNITS IN WEST REGION)
Diego Company				Segments
Projected Income Statement by Divisions
For the Year Ended 2
	Diego Company			East Regions			West Regions
	Dollars		%	Dollars		%	Dollars		%
Sales	4,316,800		100%	3,040,000		100%	1,276,800		100%
Variable Cost
Direct Material	1,306,400		30%	920,000		30%	386,400		30%
Direct Labor	852,000		20%	600,000		20%	252,000		20%
Variable Manufacturing Overheads	170,400		4%	120,000		4%	50,400		4%
Variable SG&A	170,400		4%	120,000		4%	50,400		4%
Contribution Margin	1,817,600		42%	1,280,000		42%	537,600		42%
Traceable Fixed Cost
Fixed Manufacturing Overheads(Allocated on sales basis)	1,220,148		28%	859,259		28%	360,889		28%
Fixed SG&A	638,000		15%	270,000		9%	368,000		29%
Contribution to Common fixed Cost	-40,548		-1%	150,741		5%	-191,289		-15%
Common Fixed Cost	50,000		1%
Net Operating Income	-90,548		-2%
Decision : If incur Additional advertising expenses $48,000 even then loss will be higher as compare to total loss of year 1
Loss will increase by $18,548