Question

Keep-Or-Drop Decision, Alternatives, Relevant Costs

Reshier Company makes three types of rug shampooers. Model 1 is the basic model rented through hardware stores and supermarkets. Model 2 is a more advanced model with both dry-and wet-vacuuming capabilities. Model 3 is the heavy-duty riding shampooer sold to hotels and convention centers. A segmented income statement is shown below.

		Model 1		Model 2		Model 3		Total
Sales		$230,000		$558,000		$651,000		$1,439,000
Less variable costs of goods sold		(93,000)		(158,360)		(333,200)		(584,560)
Less commissions		(4,600)		(28,500)		(22,000)		(55,100)
Contribution margin		$132,400		$371,140		$295,800		$799,340
Less common fixed expenses:
Fixed factory overhead								(420,000)
Fixed selling and administrative								(287,000)
Operating income								$92,340

While all models have positive contribution margins, Reshier Company is concerned because operating income is less than 10 percent of sales and is low for this type of company. The company’s controller gathered additional information on fixed costs to see why they were so high. The following information on activities and drivers was gathered:

						Driver Usage by Model
Activity	Activity Cost				Activity Driver	Model 1				Model 2				Model 3
Engineering		$89,000			Engineering hours		710				74				216
Setting up		182,000			Setup hours		12,800				13,400				29,216
Customer service		108,000			Service calls		13,400				1,400				19,216

In addition, Model 1 requires the rental of specialized equipment costing $20,500 per year.

Required:

1. Reformulate the segmented income statement using the additional information on activities. Use a minus sign to indicate any negative margins. Do NOT round interim calculations and, if required, round your answer to the nearest dollar. If amount box does not require an entry, leave it blank or enter "0".

Reshier Company
Segmented Income Statement
	Model 1	Model 2	Model 3	Total
Sales	$	$	$	$
Less variable cost of goods sold
Less commissions
Contribution margin	$	$	$	$
Less traceable fixed expenses:
Engineering
Setting up
Equipment rental
Customer service
Product margin	$	$	$	$
Less common fixed expenses:
Factory overhead
Selling and admin. expense
Operating income				$

Feedback

1. Review what you have learned about segmented income statements in the chapter. To determine the traceable fixed costs, you will need to compute the activity rates for each activity to assign the costs of the activities to each product. Common fixed expenses are not traceable to the segments. They would remain even if one of the segments were eliminated.

2. Using your answer to Requirement 1, assume that Reshier Company is considering dropping any model with a negative product margin. What are the alternatives?
Keeping Model 1 or dropping it

Which alternative is more cost effective and by how much? (Assume that any traceable fixed costs can be avoided.) Do NOT round interim calculations and, if required, round your answer to the nearest dollar.
Dropping Model 1  will add $ to operating income

3. What if Reshier Company can only avoid 170 hours of engineering time and 4,850 hours of setup time that are attributable to Model 1? How does that affect the alternatives presented in Requirement 2? Which alternative is more cost effective and by how much? Do NOT round interim calculations and, if required, round your answer to the nearest dollar.

Keeping Model 1  will add $ to operating income

Answer 1

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Requirement - 1
Reshier Company
Segmented Income Statement
		Model 1	Model 2	Model 3	Total
Sales		$          230,000	$             558,000	$ 651,000	$ 1,439,000
Less variable cost of goods sold		$           -93,000	$            -158,360	$-333,200	$   -584,560
Less commissions		$             -4,600	$              -28,500	$ -22,000	$     -55,100
Contribution margin		$          132,400	$             371,140	$ 295,800	$    799,340
Less traceable fixed expenses:	Working-1
Engineering		$           -63,190	$                -6,586	$ -19,224	$     -89,000
Setting up		$           -42,038	$              -44,009	$ -95,953	$   -182,000
Equipment rental		$           -20,500			$     -20,500
Customer service		$           -42,545	$                -4,445	$ -61,010	$   -108,000
Product margin		$           -35,873	$             316,100	$ 119,613	$    399,840
Less common fixed expenses:
Factory overhead	Working-2				$   -128,500
Selling and admin. expense	Working-2				$   -179,000
Operating income					$      92,340
Working-1
Calculation of Traceable Fixed expenses:
	Activity Cost	Driver Usage				Activity Rate
Activity	A	Model 1	Model 2	Model 3	Total (B)	A/B
Engineering	$       89,000	710	74	216	1,000	$          89.00
Setting up	$     182,000	12,800	13,400	29,216	55,416	$            3.28
Customer service	$     108,000	13,400	1,400	19,216	34,016	$            3.17
Allocation of Cost
	Engineering		Setting Up		Customer Service
Model 1	89*710	$            63,190	3.28*12800	$    42,038	3.17*13400	$        42,545
Model 2	89*74	$              6,586	3.28*13400	$    44,009	3.17*1400	$          4,445
Model 3	89*216	$            19,224	3.28*29216	$    95,953	3.17*19216	$        61,010
Total		$            89,000		$ 182,000		$      108,000
Working-2
		Manufacturing	Selling and amin
Total Fixed Expense		$          420,000	$             287,000
Less: Equipment Rental		$           -20,500
Less: Traceable		$         -271,000	$            -108,000
Common		$          128,500	$             179,000
Requirement - 2
Since Model 1 has negative product margin of $35,873, dropping it will be beneficialy for company
Dropping it will increase net income of company by $ 35,873
Requirement - 3
Reshier Company
Segmented Income Statement
		Model 1	Model 2	Model 3	Total
Sales		$          230,000	$             558,000	$ 651,000	$ 1,439,000
Less variable cost of goods sold		$           -93,000	$            -158,360	$-333,200	$   -584,560
Less commissions		$             -4,600	$              -28,500	$ -22,000	$     -55,100
Contribution margin		$          132,400	$             371,140	$ 295,800	$    799,340
Less traceable fixed expenses:	Working-1
Engineering	170*89	$           -15,130	$                -6,586	$ -19,224	$     -40,940
Setting up	4850*3.28	$           -15,929	$              -44,009	$ -95,953	$   -155,890
Equipment rental		$           -20,500			$     -20,500
Customer service		$           -42,545	$                -4,445	$ -61,010	$   -108,000
Product margin		$            38,297	$             316,100	$ 119,613	$    474,010
Keeping Model 1 will add $ 38,297 to Company Income