Question

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 expense	$	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 expense is traceable to the West region, $280,000 is traceable to the East region, and the remaining $52,000 is a common fixed expense. 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

Selling price per unit	77
Less: Variable expense
Direct materials	27
Direct labor	10
Variable manufacturing overhead	2
Variable selling and administrative	3
Total Variable expense	42
Contribution margin per unit	35
13
	Total company	East	West
Sales	4158000	3157000	1001000
Variable costs	2268000	1722000	546000
Contribution margin	1890000	1435000	455000
Traceable fixed expenses	610000	280000	330000
Regional segment margin	1280000	1155000	125000
Common fixed expenses not traceable to regions	1350000
Net Operating loss	(70000)
14
Loss in Contribution margin of West	-455000	=13000*35
Increase in Contribution margin of East	71750	=41000*5%*35
Avoidable fixed selling and administrative expense	330000
Net change in Profits	-53250
Profits will decrease by 53250
15
Increase in unit sales	2600	=13000*20%
X Contribution margin per unit	35
Increase in Contribution margin	91000
Less: Advertising costs	-49000
Net change in Profits	42000
Profits will increase by 42000