Question

Diego Company manufactures one product that is sold for $76 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 47,000 units and sold 42,000 units. Variable costs per unit: Manufacturing: Direct materials $ 26 Direct labor $ 10 Variable manufacturing overhead $ 2 Variable selling and administrative $ 4 Fixed costs per year: Fixed manufacturing overhead $ 987,000 Fixed selling and administrative expenses $ 475,000 The company sold 32,000 units in the East region and 10,000 units in the West region. It determined that $210,000 of its fixed selling and administrative expenses is traceable to the West region, $160,000 is traceable to the East region, and the remaining $105,000 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.

1 (a)What is the company’s break-even point in unit sales?

(b) Is it above or below the actual sales volume?

2. 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?

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

4. 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 $40,000 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?

5. Assume the West region invests $37,000 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

1. a. Company's break-even point in unit sales : 43,000 units.

b. The break-even point is above the actual sales volume of 42,000 units.

Total variable cost per unit = $ ( 26 + 10 + 2 + 4) = $ 42.

Contribution margin per unit = $ 76 - $ 42 = $ 34.

Breakeven point in sales units = Total Fixed Cost / Contribution margin per unit = $ ( 987,000 + 475,000) = $ 1,462,000 / $ 34 = 43,000 units.

2. The company's overall break-even point would still be 43,000 units.

3. Diego Company

Contribution Format Segmented Income Statement

	Total	East	West
Unit Sales	42,000	32,000	10,000
Sales Revenue	$ 3,192,000	$ 2,432,000	$ 760,000
Less: Variable Costs	1,764,000	1,344,000	420,000
Contribution Margin	$ 1,428,000	$ 1,088,000	$ 340,000
Less: Traceable Fixed Costs	370,000	160,000	210,000
Segment Margin	$ 1,058,000	928,000	130,000
Common Fixed Costs	1,092,000
Net operating income ( loss)	$ ( 34,000)

4. Effect of dropping the West Regin :

Loss of segment margin of West Region = $ (130,000)

Increase in segment margin of East Region = 32,000 units x 5% x $ 34 = $ 54,400.

Profit impact = $ 54,400 - $ 130,000 = $ 75,600 decrease.

Net operating loss will be $ ( 34,000) + $ ( 75,600 ) = $ ( 109,600)

5. Profit impact of pursuing the new advertising campaign = Increase in unit sales x Unit contribution margin - Advertising expense = 10,000 x 20% x $ 34 - $ 37,000 = $ 31,000 Increase.