Question

The following information applies to the questions displayed below.] 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 59,000 units and sold 54,000 units. Variable costs per unit: Manufacturing: Direct materials $ 27 Direct labor $ 10 Variable manufacturing overhead $ 2 Variable selling and administrative $ 3 Fixed costs per year: Fixed manufacturing overhead $ 1,298,000 Fixed selling and administrative expenses $ 662,000 The company sold 41,000 units in the East region and 13,000 units in the West region. It determined that $330,000 of its fixed selling and administrative expenses is traceable to the West region, $280,000 is traceable to the East region, and the remaining $52,000 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 $122,000 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 $49,000 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. Contribution Format Income Statement :

	Total	East	West
Sales Revenue	$ 4,158,000	$ 3,157,000	$ 1,001,000
Less: Variable Costs
Manufacturing	2,106,000	1,599,000	507,000
Selling and Administrative	162,000	123,000	39,000
Total Variable Costs	2,268,000	1,722,000	546,000
Contribution Margin	$ 1,890,000	$ 1,435,000	$ 455,000
Traceable Fixed Costs	610,000	280,000	330,000
Segment Margin	1,280,000	1,155,000	125,000
Common Fixed Cost
Manufacturing	1,298,000
Selling and Administrative	52,000
Net Operating Income ( loss)	$ ( 70,000)

14. Segment margin lost from dropping West region : $ (125,000)

Segment margin gained from increased sales of East region = ( 41,000 x 0.05) x $ 35 = $ 71,750

Impact on profit of dropping West region = $ ( 125,000) + $ 71,750 = $ ( 53,250).

Overall net operating income will decrease further by $ 53,250.

Net operating profit will decrease by $ 263,250.

15. Incremental contribution margin for West region = 13,000 x 20% x $ 35 = $ 91,000.

Incremental fixed cost : $ 49,000.

Profit impact = $ 91,000 - $ 49,000 = $ 42,000 increase.