Question

AudioMart is a retailer of radios, stereos, and televisions. The store carries two portable sound systems that have radios, tape players, and speakers. System A, of slightly higher quality than System B, costs $19 more. With rare exceptions, the store also sells a headset when a system is sold. The headset can be used with either system. Variable-costing income statements for the three products follow:

	System A	System B	Headset
Sales	$ 45,500	$ 32,600	$ 7,900
Less: Variable expenses	20,400	25,600	3,400
Contribution margin	$25,100	$7,000	$4,500
Less: Fixed costs *	9,800	17,900	2,700
Operating income (loss)	$15,300	$(10,900)	$1,800

* This includes common fixed costs totaling $17,900, allocated to each product in proportion to its revenues.

The owner of the store is concerned about the profit performance of System B and is considering dropping it. If the product is dropped, sales of System A will increase by 31%, and sales of headsets will drop by 26%. Round all answers to the nearest whole number.

	Required:
1.	Prepare segmented income statements for the three products using a better format.
2.	CONCEPTUAL CONNECTION: Prepare segmented income statements for System A and the headsets assuming that System B is dropped. Should B be dropped?
3.	CONCEPTUAL CONNECTION: Suppose that a third system, System C, with a similar quality to System B, could be acquired. Assume that with C the sales of A would remain unchanged; however, C would produce only 80% of the revenues of B, and sales of the headsets would drop by 10%. The contribution margin ratio of C is 50%, and its direct fixed costs would be identical to those of B. Should System B be dropped and replaced with System C?

Answer 1

Part 1
		System A	System B	Headset	Total
	Sales	$                 45,500	$                      32,600	$                     7,900	$           86,000
	Less:Variable expenses	$                 20,400	$                      25,600	$                     3,400	$           49,400
	Contribution margin	$                 25,100	$                        7,000	$                     4,500	$           36,600
	Less:Direct Fixed Costs	$                      330	$                      11,115	$                     1,056	$           12,500
	Segment Margin	$                 24,770	$                      -4,115	$                     3,444	$           24,100
	Less:Common Fixed Costs	$                   9,470	$                        6,785	$                     1,644	$           17,900
	Operating Income	$                 15,300	$                    -10,900	$                     1,800	$             6,200
Part 2		System A	Headset	Total
	Sales	$                 59,605	$                        5,846	$                   65,451
	Less:Variable expenses	$                 26,724	$                        2,516	$                   29,240
	Contribution margin	$                 32,881	$                        3,330	$                   29,551
	Less:Direct Fixed Costs	$                      330	$                        1,056	$                     1,385
	Segment Margin	$                 32,551	$                        2,274	$                   34,826
	Less:Common Fixed Costs	$                 16,301	$                        1,599	$                   17,900
	Operating Income	$                 16,250	$                           675	$                   16,926
	Since the dropping of System B has increased the Operating income hence System B should be dropped.
Part 3		System A	System C	Headset	Total
	Sales	$                 45,500	$                      26,080	$                     7,110	$           78,690
	Less:Variable expenses	$                 20,400	$                      13,040	$                     3,060	$           36,500
	Contribution margin	$                 25,100	$                      13,040	$                     4,050	$           42,190
	Less:Direct Fixed Costs	$                      330	$                      11,115	$                     1,056	$           12,500
	Segment Margin	$                 24,770	$                        1,925	$                     2,994	$           29,690
	Less:Common Fixed Costs	$                 10,350	$                        5,933	$                     1,617	$           17,900
	Operating Income	$                 14,420	$                      -4,007	$                     1,377	$           11,790
	System C should be introduced in place of System B as it increases the Operating Income