Question

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Diego Company manufactures one product that is sold for $71 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 42,000 units and sold 37,000 units.

Variable costs per unit:
Manufacturing:
Direct materials	$	21
Direct labor	$	12
Variable manufacturing overhead	$	3
Variable selling and administrative	$	5
Fixed costs per year:
Fixed manufacturing overhead	$	840,000
Fixed selling and administrative expense	$	330,000

The company sold 27,000 units in the East region and 10,000 units in the West region. It determined that $160,000 of its fixed selling and administrative expense is traceable to the West region, $110,000 is traceable to the East region, and the remaining $60,000 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.

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 $10,000 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?

Answer 1

Part 1 - Total Profit/Loss before Elimination of western Region under Contribution Margin Approach

Unit Variable cost of product = ($21+$12+$3) = $36

Particulars	Amount
Sales (27000 + 10000)* $71 Per unit	$2627000
Less : Cost of goods sold (Note 1)	$1332000
Less : Variable selling and administrative expenses ($5*37000 units)	$185000
Contribution Margin	$111000
Less : Fixed Manufacturing overhead	$840000
Less : Fixed selling and administrative expenses	$330000
Net Loss	$60000

Note 1 - Cost of goods sold

Particulars	Amount
Beginning Inventory	$0
+ Cost of goods manufactured ($36*42000 units)	$1512000
- Ending Inventory (42000 - 37000)*$36	($180000)
Cost of goods sold	$1332000

Part 2 - Profit/Loss on elimination of West region

Total units sold = (27000 + 5%) = 28350 units

Particulars	Amount
Sales 28350 units * $71 per unit	$2012850
Less : Cost of goods sold ($36*28350 units)	$1020600
Less : variable selling expenses (28350*$3)	$85050
Contribution Margin	$907200
Less : Fixed Manufacturing overhead ($840000+$60000)	$900000
Less : Traceable Fixed Selling expenses	$110000
Net Loss	$102800

Increase in loss if West region Eliminated =

($102800 - $60000) = $42800 Increase in loss

Decision - West region should not be closed