Question

Ontario Pump Company, a small manufacturing company in Toronto, Ontario, manufactures three types of pumps used in a variety of applications. For many years the company has been profitable and has operated at capacity. However, in the last two years prices on all pumps were reduced and selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter results for the current year, which follow, typify recent experience.

  

ONTARIO PUMP COMPANY
Income Statement
Second Quarter
(in thousands)
	R-Pump			F-Pump			S-Pump			Total
Sales	$	6,300		$	4,070		$	3,840		$	14,210
Cost of goods sold		4,127			3,483			4,053			11,663
Gross margin	$	2,173		$	587		$	(213	)	$	2,547
Selling and administrative expenses		1,457			837			576			2,870
Income before taxes	$	716		$	(250	)	$	(789	)	$	(323	)

  

Maria Carlo, the company's president, is concerned about the results of the pricing, selling, and production prices. After reviewing the second-quarter results she asked her management staff to consider the following three suggestions:

•	Discontinue the S-Pump line immediately. S-Pumps would not be returned to the product line unless the problems with the pump can be identified and resolved.
•	Increase quarterly sales promotion by $400,000 on the R-Pump product line in order to increase sales volume by 15 percent.
•	Cut production on the F-Pump line by 50 percent, and cut the traceable advertising and promotion for this line to $110,000 each quarter.

Justin Sperry, the controller, suggested a more careful study of the financial relationships to determine the possible effects on the company’s operating results of the president’s proposed course of action. The president agreed and assigned JoAnn Brower, the assistant controller, to prepare an analysis. Brower has gathered the following information.

•	The unit sales prices for the three pumps are as follows:

R-Pump	$	700
F-Pump		370
S-Pump		640

•	The company is manufacturing at capacity and is selling all the pumps it produces.

•	All three pumps are manufactured with common equipment and facilities.
•	The selling and administrative expense is allocated to the three pump lines based on average sales volume over the past three years.
•	Special selling expenses (primarily advertising, promotion, and shipping) are incurred for each pump as follows:

	Quarterly Advertising and Promotion			Shipping Expenses
R-Pump	$	730,000		$	40	per unit
F-Pump		400,000			22	per unit
S-Pump		220,000			80	per unit

•	The unit manufacturing costs for the three pumps are as follows:

	R-Pump			F-Pump			S-Pump
Direct material	$	103.00		$	61.00		$	160.00
Direct labor		140.00			80.00			200.00
Variable manufacturing overhead		155.00			110.00			200.00
Fixed manufacturing overhead		60.56			65.64			115.50
Total	$	458.56		$	316.64		$	675.50

Required:

2.	Use the operating data presented for Ontario Pump Company and assume that the president's proposed course of action had been implemented at the beginning of the second quarter.

a.	Calculate the net impact on income before taxes for each of the three suggestions.

Answer 1

Q2)

The above income statement has been prepared taking in view all the suggestions by the president.

Working notes: