Question

Valdespin Company manufactures three sizes of camping tents—small (S), medium (M), and large (L). The income statement has consistently indicated a net loss for the M size, and management is considering three proposals: (1) continue Size M, (2) discontinue Size M and reduce total output accordingly, or (3) discontinue Size M and conduct an advertising campaign to expand the sales of Size S so that the entire plant capacity can continue to be used.

If Proposal 2 is selected and Size M is discontinued and production curtailed, the annual fixed production costs and fixed operating expenses could be reduced by $46,080 and $32,240, respectively. If Proposal 3 is selected, it is anticipated that an additional annual expenditure of $34,560 for the rental of additional warehouse space would yield an additional 130% in Size S sales volume. It is also assumed that the increased production of Size S would utilize the plant facilities released by the discontinuance of Size M.

The sales and costs have been relatively stable over the past few years, and they are expected to remain so for the foreseeable future. The income statement for the past year ended June 30, 20Y9, is as follows:

	Size
	S		M		L		Total
Sales	$668,000		$737,300		$956,160		$2,361,460
Cost of goods sold:
Variable costs	$(300,000)		$(357,120)		$(437,760)		$(1,094,880)
Fixed costs	(74,880)		(138,250)		(172,800)		(385,930)
Total cost of goods sold	$(374,880)		$(495,370)		$(610,560)		$(1,480,810)
Gross profit	$293,120		$241,930		$345,600		$880,650
Operating expenses:
Variable expenses	$(132,480)		$(155,500)		$(195,840)		$(483,820)
Fixed expenses	(92,160)		(103,680)		(115,200)		(311,040)
Total operating expenses	$(224,640)		$(259,180)		$(311,040)		$(794,860)
Operating income (loss)	$68,480		$(17,250)		$34,560		$85,790

Required:

1. Prepare an income statement for the past year in the variable costing format. Data for each size should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin, as reported in the “Total” column, to determine operating income.

Valdespin Company
Variable Costing Income Statement
For the Year Ended June 30, 20Y9
	Size S	Size M	Size L	Total
Sales	$	$	$	$
Variable cost of goods sold
Manufacturing margin	$	$	$	$
Variable operating expenses
Contribution margin	$	$	$	$
Fixed costs:
Manufacturing costs				$
Operating expenses
Total fixed costs				$
Operating income				$

2. Based on the income statement prepared in (1) and the other data presented, determine the amount by which total annual operating income would be reduced below its present level if Proposal 2 is accepted.
$

3. Prepare an income statement in the variable costing format, indicating the projected annual operating income if Proposal 3 is accepted. Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin as reported in the “Total” column. For purposes of this problem, the expenditure of $34,560 for the rental of additional warehouse space can be added to the fixed operating expenses.

Valdespin Company
Variable Costing Income Statement
For the Year Ended June 30, 20Y9
	Size S	Size L	Total
Sales	$	$	$
Variable cost of goods sold
Manufacturing margin	$	$	$
Variable operating expenses
Contribution margin	$	$	$
Fixed costs:
Manufacturing costs			$
Operating expenses
Total fixed costs			$
Operating income			$

4. By how much would total annual operating income increase above its present level if Proposal 3 is accepted?
$

Answer 1

1. First up we need to make an income statement from the perspective that Size M will be continued. This is very straightforward and only needs figures to be added in the new format. Refer to the solution below.

Valdespin Company
Variable Costing Income Statement
For the year ended June 20, 2009
Particuliars	Size S	Size M	Size L	Total
Sales	$668,000	$737,300	$956,160	$2,361,460
Variable cost of goods sold	($300,000)	($357,120)	($437,760)	($1,094,880)
Manufacturing Margin	$368,000	$380,180	$518,400	$1,266,580
Variable Operating Expenses	($132,480)	($155,500)	($195,840)	($483,820)
Contribution Margin	$235,520	$224,680	$322,560	$782,760
Fixed Costs:
Manufacturing Costs	($74,880)	($138,250)	($172,800)	($385,930)
Operating Expenses	($92,160)	($103,680)	($115,200)	($311,040)
Total Fixed Costs	($167,040)	($241,930)	($288,000)	($696,970)
Operating Income	$68,480	($17,250)	$34,560	$85,790

Variable cost of goods sold is derived from the cost of goods sold section under variable expenses and Variable Operating expenses is derived from the Operating expenses section under variable.

For fixed costs, Manufacturing costs are those fixed costs which are included in costs of goods sold and Operating expenses are the fixed element that has been included.

2. For section 2 lets use a reverse approach lets take the current operating income and then add/subtract the effects of discontinuing Size M. Refer to the table below

Particuliars	Amt	Amt
Operating Income		$85,790
Less: Loss of Revenue	($737,300)
Add: Variable Cost of Goods sold	$357,120
Add: Variable Operating expenses	$155,500
Add: Manufacturing costs	$46,080
Add: Fixed Operating Expenses	$32,240
Net increase/(decrease)		($146,360)
Profit/(loss)		($60,570)

Lets go through line item at a time.

Loss of revenue is due to no units of Size M being sold thus it would be deduction operating income.

Variable COGS and Operating expenses will not be incurred as a result of no production, thus this would result in increase in income and hence is added back.

For fixed expenses there is a note mentioned with states that only a certain amount can be reduced and thus we have added back only those figures.

As a result the net decrease is $146360 resulting in a loss of $60570 if Proposal 2 is accepted.

3. If proposal 3 was accepted the income statement would be as follows.

Valdespin Company
Variable Costing Income Statement
For the year ended June 20, 2009
Particuliars	Size S	Size L	Total
Sales	$868,400	$956,160	$1,824,560
Variable cost of goods sold	($300,000)	($437,760)	($737,760)
Manufacturing Margin	$568,400	$518,400	$1,086,800
Variable Operating Expenses	($132,480)	($195,840)	($328,320)
Contribution Margin	$435,920	$322,560	$758,480
Fixed Costs:
Manufacturing Costs	($74,880)	($172,800)	($247,680)
Operating Expenses	($126,720)	($115,200)	($241,920)
Total Fixed Costs	($201,600)	($288,000)	($489,600)
Operating Income	$234,320	$34,560	$268,880

There are only two changes - the first one is the Sales figure for Size M which has been increased to 130% and the additional warehouse expense has been added to Operating expenses under fixed costs. (92160+34560)

4.

Particuliars	Amt
Income as per P1	$85,790
Income as per P3	$268,880
Net Increase	$183,090

Thus the increase is $183090

The 4th part is pretty straight forward just find the difference income from P1 and P2.