Question

The management accountant for Tony's Skateboard Company has prepared the following segmented income statement for each of its three product lines.

                                               Jammer         Cruise        Flight       Total

      Sales                                $400,000     $250,000    $350,000 $1,000,000

      Variable expenses             260,000       150,000      190,000   600,000

      Contribution margin          140,000       100,000      160,000   400,000

      Other costs                        20,000       30,000      20,000   70,000

      Segment margin                120,000         70,000      140,000   330,000

      Allocated avoidable costs 30,000       30,000      20,000   80,000

      Segment income                 90,000         40,000      120,000   250,000

      Allocated corporate costs 50,000       50,000      50,000   150,000

      Corporate profit                $40,000     $(10,000)      $70,000 $100,000

Required:

a. Do you recommend dropping the Cruise product line? Why or why not?

b. If the Jammer product line had been discontinued, the short-term effect on corporate profits would be a decrease of what amount?

c. Assume that the Flight product line has been discontinued and long-term capacity has had time to adjust. The projected long-term effect of this action on annual corporate profits would be a decrease of what amount?

d. Assume that an advertising campaign could increase revenues for any of the products by $15,000. To maximize corporate profits, which product line should receive the advertising dollars? Why?

e. How would you change the format of the segment margin statement above to make it more understandable?

Answer 1

a.            No, Won’t recommend dropping the Cruise product line because,

70,000 margin of that particular segment tells you that the segment is contributing 70,000.

And also the income of the segment is $40,000 including available costs.

b.            When the Jammer product line discontinued,

profits would immediately decrease by $140,000 which is the exact amount of contribution made by the product line. And all fixed costs attributed to Jammer cant be avoided.

c.             Flight product line were discontinued and long-term capacity has had time to adjust, corporate profits would decrease = contribution – avoidable costs = 160000-40000= $120,000, the amount reported for the segment income.

d.            To maximize corporate profits, the Flight product line should receive the advertising dollars because it has a contribution margin of approximately 40%(160,000/400,000), the highest contribution margin of the three product lines.

e.            Present Statement of segment margins could be made more understandable, when the allocated corporate costs were only listed under the company total column.

Not made as a part of the computation for each product line segment.

It is obvious that the corporate costs are arbitrarily allocated equally to each product line and arbitrary allocations do not aid in decision making.