Question

Segment variable costing income statement and effect on operating income of change in operations

Valdespin Company manufactures three sizes of camping tents—small (S), medium (M), and large (L). The income statement has consistently indicated a net loss for the M size, and management is considering three proposals: (1) continue Size M, (2) discontinue Size M and reduce total output accordingly, or (3) discontinue Size M and conduct an advertising campaign to expand the sales of Size S so that the entire plant capacity can continue to be used.

If Proposal 2 is selected and Size M is discontinued and production curtailed, the annual fixed production costs and fixed operating expenses could be reduced by $46,080 and $32,240, respectively. If Proposal 3 is selected, it is anticipated that an additional annual expenditure of $34,560 for the rental of additional warehouse space would yield an additional 130% in Size S sales volume. It is also assumed that the increased production of Size S would utilize the plant facilities released by the discontinuance of Size M.

The sales and costs have been relatively stable over the past few years, and they are expected to remain so for the foreseeable future. The income statement for the past year ended June 30, 20Y9, is as follows:

	Size
	S		M		L		Total
Sales	$668,000		$737,300		$956,160		$2,361,460
Cost of goods sold:
Variable costs	$(300,000)		$(357,120)		$(437,760)		$(1,094,880)
Fixed costs	(74,880)		(138,250)		(172,800)		(385,930)
Total cost of goods sold	$(374,880)		$(495,370)		$(610,560)		$(1,480,810)
Gross profit	$293,120		$241,930		$345,600		$880,650
Operating expenses:
Variable expenses	$(132,480)		$(155,500)		$(195,840)		$(483,820)
Fixed expenses	(92,160)		(103,680)		(115,200)		(311,040)
Total operating expenses	$(224,640)		$(259,180)		$(311,040)		$(794,860)
Operating income (loss)	$68,480		$(17,250)		$34,560		$85,790

Required:

1. Prepare an income statement for the past year in the variable costing format. Data for each size should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin, as reported in the “Total” column, to determine operating income.

Valdespin Company
Variable Costing Income Statement
For the Year Ended June 30, 20Y9
	Size S	Size M	Size L	Total
Sales	$	$	$	$
Variable cost of goods sold
Manufacturing margin	$	$	$	$
Variable operating expenses
Contribution margin	$	$	$	$
Fixed costs:
Manufacturing costs				$
Operating expenses
Total fixed costs				$
Operating income				$

Feedback

1. For each size and in total compute the following:
Sales - variable cost of goods sold = manufacturing margin; Manufacturing margin - variable operating expenses = contribution margin; at this point subtract fixed manufacturing costs and operating expenses from the total contribution margin to obtain the total Operating income.

2. Based on the income statement prepared in (1) and the other data presented, determine the amount by which total annual operating income would be reduced below its present level if Proposal 2 is accepted.
$

Feedback

2. Contribution margin for Size M - reduction in fixed production costs - reduction in fixed operating expenses = reduction in annual operating income

3. Prepare an income statement in the variable costing format, indicating the projected annual operating income if Proposal 3 is accepted. Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin as reported in the “Total” column. For purposes of this problem, the expenditure of $34,560 for the rental of additional warehouse space can be added to the fixed operating expenses.

Valdespin Company
Variable Costing Income Statement
For the Year Ended June 30, 20Y9
	Size S	Size L	Total
Sales	$	$	$
Variable cost of goods sold
Manufacturing margin	$	$	$
Variable operating expenses
Contribution margin	$	$	$
Fixed costs:
Manufacturing costs			$
Operating expenses
Total fixed costs			$
Operating income			$

Feedback

3. Recast the income statement using the same format as in requirement (1) with only S and L sizes.
After computing contribution margin for S, L and total, subtract fixed manufacturing costs and operating expenses from the total contribution margin to obtain the total operating income.

4. By how much would total annual operating income increase above its present level if Proposal 3 is accepted?

Answer 1