Question

Diego Company manufactures one product that is sold for $75 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 57,000 units and sold 52,000 units.

Variable costs per unit:
Manufacturing:
Direct materials	$	25
Direct labor	$	18
Variable manufacturing overhead	$	3
Variable selling and administrative	$	5
Fixed costs per year:
Fixed manufacturing overhead	$	627,000
Fixed selling and administrative expense	$	645,000

The company sold 36,000 units in the East region and 16,000 units in the West region. It determined that $310,000 of its fixed selling and administrative expense is traceable to the West region, $260,000 is traceable to the East region, and the remaining $75,000 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.

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

14. 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 $22,000 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 5% 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?

15. Assume the West region invests $47,000 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

13. In the give case, the sales price and cost details are given, based on it the contribution format statement is as follows:

	East Region	West Region	Total Company
Sales	$2700000	`$1200000	$3900000
Less: variable cost
Direct Material	900000	400000	1300000
Direct Labor	648000	288000	936000
Variable manufacturing Overhead	108000	48000	156000
Variable Selling Overhead	180000	80000	260000
Total Variable Expenses	1836000	816000	2652000
Contribution Margin	$864000	$384000	$1248000
Less: Traceable Fixed cost
Fixed Selling and administrative overhead	260000	310000	570000
Division Operating Income	$604000	$74000	$678000
Less : Common Fixed cost
Fixed manufacturing Overhead			627000
Fixed Selling and administrative overhead			75000
Operating Loss			$-24000

Here both the divisions are at profit but the overall company is in loss, of $ 24000 due to its huge fixed overheads.

2. If west region is dropped the variable costs and fixed traceable overheads will be saved, so based on it the income statement and the impact on profit will be as follows:

	East Region
Sales	2835000
Less: variable cost
Direct Material	945000
Direct Labor	680400
Variable manufacturing Overhead	113400
Variable Selling Overhead	189000
Total Variable Expenses	1927800
Contribution Margin	907200
Less: Traceable Fixed cost
Fixed Selling and administrative overhead	260000
Division Operating Income	647200
Less : Common Fixed cost
Fixed manufacturing Overhead	627000
Fixed Selling and administrative overhead	75000
Operating Income	-54800

Here if the west region is dropped then the traceable fixed overheadof west division will not be incurred and other fixed cost pertaining to the east division will be there, Here there is an additional loss of $ 30800 if the west divion is dropped for the company as a whole as only 1 division wll be left.

3.   West region invests $47,000 in a new advertising campaign in Year 2 that increases its unit sales by 20% , here the additional traceable fixed cost will increased by $ 47000 and sales units will be 19200

	East Region	West Region	Total Company
Sales	2700000	1440000	4140000
Less: variable cost
Direct Material	900000	480000	1380000
Direct Labor	648000	345600	993600
Variable manufacturing Overhead	108000	57600	165600
Variable Selling Overhead	180000	96000	276000
Total Variable Expenses	1836000	979200	2815200
Contribution Margin	864000	460800	1324800
Less: Traceable Fixed cost
Fixed Selling and administrative overhead	260000	357000	617000
Division Operating Income	604000	103800	707800
Less : Common Fixed cost
Fixed manufacturing Overhead			627000
Fixed Selling and administrative overhead			75000
Operating Income			5800

Here the West division profit will increase from $ 74000 to $ 103800 net increse of $ 29800, and the operating income fro the company will rise from a loss of $ 24000 to  income of $ 5800 , so there is a net increase of $ 29800.