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 46,000 units and sold 42,000 units.

  

Variable costs per unit:
Manufacturing:
Direct materials	$	25
Direct labor	$	20
Variable manufacturing overhead	$	2
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	644,000
Fixed selling and administrative expenses	$	388,000

  

The company sold 31,000 units in the East region and 11,000 units in the West region. It determined that $200,000 of its fixed selling and administrative expenses is traceable to the West region, $150,000 is traceable to the East region, and the remaining $38,000 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.

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 $46,000 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 $36,000 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)

Particulars	Total Company	East Region	West Region
Units	42000 Units	31000 Units	11000 Units
Sales ($75)	$        3,150,000	$ 2,325,000	$       825,000
Variable Expenses ($51)	$        2,142,000	$ 1,581,000	$       561,000
Contribution Margin	$        1,008,000	$     744,000	$       264,000
Traceable Fixed Expenses	$            350,000	$     150,000	$       200,000
Region Segment Margin	$            658,000	$     594,000	$         64,000
Non Traceable Fixed Expenses
($644,000+$38,000)	$            682,000
Net Operating Loss	$            (24,000)

14)

Since the total gross margin in the West region equals $154,000. From above table, the unit product cost under absorption costing is $61; therefore the gross margin per unit is $14 ($75 – $61). The West region’s total gross margin of $154,000 (11,000 units × $14 per unit) is less than its traceable fixed expenses of $200,000. It is concluded that the West region should be discontinued.

The contribution format segmented income statements as follows:

Segment margin in the West region	$(64,000)
Additional contribution margin in East region ($744,000*5%)	$  37,200
Decrease in profits if the West region is dropped	$  (26,800)

15)

The Profit impact is computed as follows:

                Additional Advertising                                                                                                   $(36000)

                Additional Contribution Margin in the West region ($264,000*20%) $52,800

                Increase in Profits $16,800