Question

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Diego Company manufactures one product that is sold for $77 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 48,000 units and sold 43,000 units.

  

Variable costs per unit:
Manufacturing:
Direct materials	$	27
Direct labor	$	12
Variable manufacturing overhead	$	3
Variable selling and administrative	$	5
Fixed costs per year:
Fixed manufacturing overhead	$	864,000
Fixed selling and administrative expenses	$	456,000

  

The company sold 33,000 units in the East region and 10,000 units in the West region. It determined that $220,000 of its fixed selling and administrative expenses is traceable to the West region, $170,000 is traceable to the East region, and the remaining $66,000 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. 9. If the sales volumes in the East and West regions had been reversed, what would be the company’s overall break-even point in unit sales? 10. What would have been the company’s variable costing net operating income (loss) if it had produced and sold 43,000 units?    11. What would have been the company’s absorption costing net operating income (loss) if it had produced and sold 43,000 units?    12. If the company produces 5,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year 2? Lower Higher 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 $50,000 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 $38,000 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
	Unit Product cost under variable costing
	Direct Material	$                             27.00
	Direct Labor	$                             12.00
	Variable manufacturing overhead	$                               3.00
	Fixed Manufacturing Overhead
		$                             42.00
	Unit Product cost under absorption costing
	Direct Material	$                             27.00
	Direct Labor	$                             12.00
	Variable manufacturing overhead	$                               3.00
	Fixed Manufacturing Overhead($864000/48000)	18.00
		$                             60.00
	Break even point in units
	Contribution margin (43000*$77-43000*$47)	$              12,90,000.00
	Units Sells	$                    43,000.00
	Contribution margin per unit=($1290000/43000)=(A)	$                             30.00
	Fixed Cost=(B)=($864000+$456000)	$              13,20,000.00
	Break even point in units=Fixed cost/Contribution margin per unit=(B)/(A)	44000
9)	Overall break even point will be same as 44000 units because the contribution margin per units and fixed cost will be the same.
10)	Net income under variable costing
	Units Sales	$                    43,000.00
	sales=(B)=(A)*$77	$              33,11,000.00
	Variable cost
	Variable cost of goods sold(43000*$42)	$              18,06,000.00
	Variable selling and administrative expenses	$                 2,15,000.00
	Total Variable Expenses	$              20,21,000.00
	Contribution=(Sales-Variable Expenses)	$              12,90,000.00
	Fixed Cost
	Less: Fixed manufacturing cost	$                 8,64,000.00
	Less: Fixed selling & Administrative expenses	$                 4,56,000.00
	Net Operative Income	$                   -30,000.00
11)	If the units produced and sold are same absorption costing net operating income will also be same as variable costing income because difference in two method arises only when production units are more then selling units.
12)	Absorption costing income will be lower than variable costing income
	Reason: Variable costing includes only fixed expense of current year but absorption costing income statement fixed expenses portion of ending inventory of year 1 is also carried.
13)		Segmented Income Statement
		Total Company	East	West
	Sales(33000*$77),(10000*$77)	$              33,11,000.00	$                             25,41,000.00	$          7,70,000.00
*	Variable expenses=(33000*$47),(10000*$47)	$              20,21,000.00	$                             15,51,000.00	$          4,70,000.00
	Contribution Margin	$              12,90,000.00	$                                9,90,000.00	$          3,00,000.00
	Less: Traceable Fixed Cost	$                 3,90,000.00	$                                1,70,000.00	$          2,20,000.00
	Region Segment Margin	$                 9,00,000.00	$                                8,20,000.00	$              80,000.00
**	Common Fixed Expenses	$                 9,30,000.00
	Net Operating Income	$                   -30,000.00
	Variable price per unit
	Variable manufacturing expenses	$                             42.00
	Variable selling and administrative expenses	$                               5.00
	Variable price per unit	$                             47.00
**	Common Fixed Expenses
	Fixed Manufacturing expenses	$                 8,64,000.00
	Fixed selling expenses($456000-$170000-120000)	$                    66,000.00
	Common Fixed Expenses	$                 9,30,000.00
14)	If company discontinued West Region in Year 2
	Gross Margin Foregone of the West Region	$                  (80,000.00)
	Additional Contribution Margin of East Region($990000*5%)	$                    49,500.00
	Decrease in profit if west region is dropped	$                  (30,500.00)
15)	What would be the impact of pursuing the advertisement campaign
	Increased contribution of west Region($300000*20%)	$                    60,000.00
	Less: Advertisement Expenses	$                   -38,000.00
	Increase in Profit	$                    22,000.00