Question

Diego Company manufactures one product that is sold for $72 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 55,000 units and sold 50,000 units.

Variable costs per unit:
Manufacturing:
Direct materials	$	23
Direct labor	$	14
Variable manufacturing overhead	$	3
Variable selling and administrative	$	5
Fixed costs per year:
Fixed manufacturing overhead	$	770,000
Fixed selling and administrative expense	$	607,000

The company sold 37,000 units in the East region and 13,000 units in the West region. It determined that $290,000 of its fixed selling and administrative expense is traceable to the West region, $240,000 is traceable to the East region, and the remaining $77,000 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 $56,000 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 $45,000 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

Sa es...... Variable expenses . Contribution margin.... .. Traceable fixed expenses........ Region segment margin. Common fixed expenses not traceable to regions ($770,000 $77,000) Net operating loss Total $3,600,000 2.250.000 1,350,000 530.000 $820,000 East $2,664,000 1.665.000 999,000 240.000 $759.000 West $936,000 585.000 351,000 290.000 $61.000 $847.000 $ (27.000) East 37,000 units $72 per unit = $2,664,000; West: 13,000 units * $72 per unit= $936,000. * East: 37.000 units * $45 per unit = $1,665.000; West: 13.000 units X $45 per unit= $585.000 The unit product cost under variable costing? DM + DL + VMOH+VSA23 + 14 +3.5 = 345 The unit product cost under absorption costing? 545 + (Fixed 770000/56000) = $59 Point 14. absorption cost Diego has apparently determined that the total gross margin in the West region equals $169,000. As computed the unit product cost under absorption costing is $59. therefore the gross margin per unit is $13 ($72- $59). The West region's total gross margin of $169,000 (13,000 units * $13 per unit) is less than its traceable fixed expenses of $290,000. This mode of analysis creates the illusion that the West region should be discontinued. S169000 (13,Weates the illusion than The correct way to answer this question is to focus on the information in the contribution format segmented income statements as follows: Fargone segment margin in the West region $(61,000) Additional contribution margin in East region $49.950 Decrease in profits if the West region is dropped $ (11.050) $999,000 * 5% = 549,950. Point 15. The profit impact is computed as follows Additional advertising... Additional contribution margin in the West region..... Increase in profits $(45,000) 70.200 5 25.200 *$351.000 * 20% - $72,000.

West Total $3,600,000 2,250.000 1,350,000 530,000 S820 000 East $936,000 585,000 351,000 290 000 $81000 $2,664,000 Sales. Variable expenses Contribution margin. Traceable fixed expenses 1665,000 999,000 240,000 $759.000 Region segment margin Common fixed expenses not traceable to regions ($770,000 S77,000) Net operating loss $847,000 $ (27,000) East 37,000 units x $72 per unit $2,664,000; West: 13,000 units x $72 per unit $936,000. East: 37,000 units $45 per unit $1,665,000 West: 13,000 units x $45 per unit S585,000 The unit product cost under variable costing? DM+ DL+VMOHVSA 23+14+ 3+5 $45 $59 The unit product cost under absorption costing? $45+(Fixed 770000 55000) Point 14 Diego has apparently determined that the total gross margin in the West region equals $169,000. As computed the unit product cost under absorption costing is $59, therefore the gross margin per unit is $13 ($72- $59). The West region's total gross margin of $169.000 (13,000 units x $13 per unit) is less than its traceable fixed expenses of S290,000. This mode of analysis creates the illusion that the West region should be discontinued. The correct way to answer this question is to facus on the information in the contribution format segmented income statements as follows Fargone segment margin in the West rogion. Additional contribution margin i East region Decrease in profits if the West region is dropped $(61,000) $49.950 S(11.050 $999,000x5% = S49,950. Point 15 The profit impact is computed as folows $(45,000) Additianal advertising Additional cantribution margin in the West region Increase in profits 70 200 S 25,200 $351,000 x 20% - $ 72,000