Question

Exercise D8-19 Luis Herrera, an up-and-coming fashion designer, created a new line of men’s fashion socks in response to the growing number of celebrities who are expressing their individuality by replacing traditional navy and black socks with brighter colors and bold patterns. At a sales price of $9.95 per pair, Luis estimates monthly sales volume will be 20,300 pairs. Variable product costs will be $6.30 per pair and fixed overhead will be $1.60 per pair. Half of the fixed overhead is directly traceable to the new sock line. To promote the socks, Herrera proposes a $0.55 per pair commission to the company’s salespeople and a $10,050 per month advertising campaign. In compliance with corporate policy, the socks will also be allocated $24,900 in fixed corporate support costs.

B: Prepare a traditional monthly income statement for the proposed sock line. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Luis Herrera Monthly Income Statement $ $ $ Prepare a monthly income statement that highlights the proposed sock line’s segment margin. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Luis Herrera Monthly Income Statement $

C: Which income statement would you recommend that Luis use when pitching the proposed sock line to company managers?

Answer 1

• All working forms part of the answer
• Traditional Income Statement:

Under traditional income statement, fixed overheads (traceable and allocated) are also considered as part of the product.

Sales Revenue	[20300 pairs x $9.95]	$                    2,01,985.00
Expenses:
Cost of Goods Sold	[20300 x ($6.3 + $1.6)]	$                    1,60,370.00
Sales Commission	[20300 x 0.55]	$                        11,165.00
Advertising campaign		$                        10,050.00
Support cost		$                        24,900.00
Total expense		$                    2,06,485.00
Net Income (Loss)		$                        (4,500.00)

• Income Statement showing Segment Margin

Under this only those fixed expenses are considered that are relevant or traceable to the product considered:

Sales Revenue	[20300 pairs x $9.95]	$                    2,01,985.00
Less: Variable costs
Variable product cost	[20300 x $6.3]	$                    1,27,890.00
Sales Commission	[20300 x 0.55]	$                        11,165.00
Total Variable cost		$                    1,39,055.00
Contribution margin	[201985 - 139055]	$                        62,930.00
Less: Traceable fixed overhead
Fixed product overhead (50%)	[20300 x 1.6 x 50%]	$                        16,240.00
Advertising Campaign		$                        10,050.00
Total traceable overhead	[16240 + 10050]	$                        26,290.00
Segment margin		$                        36,640.00

• Since under Segment margin approach, the true profitability of the new product gets reflected, the same should be recommended.

The traditional income statement approach should not be recommended as it considers ‘allocated’ fixed cost that are not relevant when pitching the new product line.