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		$	1,600				$	900				$	900				$	3,400
Cost of goods sold			1,048					770					950					2,768
Gross margin		$	552				$	130				$	(50	)			$	632
Selling and administrative expenses			370					185					135					690
Income before taxes		$	182				$	(55	)			$	(185	)			$	(58	)

  

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 $100,000 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 $20,000 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		$	210,000				$	10		per unit
E-gauge			100,000					4		per unit
R-gauge			40,000					10		per unit

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

		Q-Gauge					E-Gauge					R-Gauge
Direct material		$	31				$	17				$	50
Direct labor			40					20					60
Variable manufacturing overhead			45					30					60
Fixed manufacturing overhead			15					10					20
Total		$	131				$	77				$	190

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

Q-gauge	$	200
E-gauge		90
R-gauge		180

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

Required:

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.

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

b-1. Calculate contribution margin for R-gauge

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

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

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

Answer 1

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