Question

Keep-or-Drop, Services, Qualitative Aspects

Jem Dawson owns Jem’s Special Event Planning Service, a full-service event planner. Jem does much of the work herself and hires additional help as needed. She plans corporate events, weddings, and special occasion parties. Each of these is considered a separate line of business due to the specialized aspects of each type of event. Last year, Jem’s accountant provided the following segmented income statement:

		Corporate		Wedding		Special Occasion		Total
Revenue		$55,300		$195,000		$168,000		$418,300
Less variable costs		(22,120)		(97,500)		(50,400)		(170,020)
Contribution margin		$33,180		$97,500		$117,600		$248,280
Less common fixed expenses:
Fixed operating expense								(175,000)
Fixed selling								(55,000)
Operating income								$18,280

Jem was not pleased with last year’s results; corporate events were down considerably from the previous few years. In addition, she thinks that dealing with the corporate party-throwers may be more work than it is worth. Two important aspects of event planning are negotiating with vendors (e.g., caterers, florists, bands and orchestras, and venues) on price and setting up for and being present at the event itself. The corporate negotiating seemed to consume extra time, and their restrictions on the price they would pay made the negotiations particularly difficult. She decided to gather some data on the negotiation and setting-up activities:

	Corporate	Wedding	Special Occasion
Negotiating hours	400	1,200	400
Setting-up hours	100	400	500
Total cost of negotiating	$40,000
Total cost of setting up	$60,000

Required:

1. Prepare a segmented income statement using the activity data for negotiating and setting up. The total cost of these two activities can be subtracted from the fixed operating expense. The remaining fixed operating expense will be the common fixed operating expense.

Jem's Special Event Planning Service
Segmented Income Statement
	Corporate	Wedding	Special Occasion	Total
Revenues	$	$	$
Less variable costs
Contribution margin	$	$	$	$
Less direct fixed expenses:
Negotiating
Setting up
Product margin	$	$	$	$
Less common fixed expenses:
Operating expense
Selling
Operating income				$

Feedback

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. Jem believes that next year will be even worse. Her hunch is that corporate business will be down and that these clients will be especially intent on saving money by reducing the rate paid to Jem. She believes total corporate revenue may decrease by 25 percent overall, while the variable costs associated with those events will only decrease by 20 percent. On the other hand, Jem expects weddings to increase. Her reputation is growing and she thinks she can raise her revenues in this area by 15 percent even if the number of weddings does not increase. As a result, she expects variable costs of weddings to remain static. The special occasions (wedding anniversary parties, bar and bat mitzvahs, and so on) line is also expected to increase—with revenue and variable costs expected to increase by 10 percent. Jem does not know quite what to expect with respect to the negotiating and setting-up activities, so she thinks she’ll just keep those constant for planning purposes. Prepare a segmented income statement using the activity data and these assumptions.

Jem's Special Event Planning Service
Segmented Income Statement
	Corporate	Wedding	Special Occasion	Total
Revenues	$	$	$	$
Less variable costs
Contribution margin	$	$	$	$
Less direct fixed expenses:
Negotiating
Setting up
Product margin	$	$	$	$
Less common fixed expenses:
Operating expense
Selling
Operating income				$

Feedback

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.

What does this income statement suggest about dropping the corporate segment?

The corporate line is losing profitability.

Answer 1

1.

Prepare the segmented income statement using the activity data for negotiating and setting up as follows:

Jem's Special Event Planning Service
Segmented Income Statement
	Corporate	Wedding	Special Occasion	Total
Revenues	$ 55300	$ 195000	$ 168000	$ 418300
Less variable costs	- $ 22120	- $ 97500	- $ 50400	- $ 170020
Contribution margin	$ 33180	$ 97500	$ 117600	$ 248280
Less direct fixed expenses:
Negotiating	- 8000	- 24000	- 8000	- 40000
Setting up	- 6000	- 24000	- 30000	- 60000
Product margin	$ 19180	$ 49500	$ 79600	$ 148280
Less common fixed expenses:
Operating expense				- 75000
Selling				- 55000
Operating income				$ 18280

Here, corporate events has lower contribution margin as compared to weddings and special occasion parties.

2. Prepare a segmented income statement using the activity data and these assumptions as follows:

Jem's Special Event Planning Service
Segmented Income Statement
	Corporate	Wedding	Special Occasion	Total
Revenues	41475	224250	184800	450525
Less variable costs	-17696	-97500	-55400	-170636
Contribution margin	23779	126750	129360	279889
Less direct fixed expenses:
Negotiating	-8000	-24000	-80000	-40000
Setting up	-6000	-24000	-30000	-60000
Product margin	9779	78750	91360	179889
Less common fixed expenses:
Operating expense				-75000
Selling				-55000
Operating income				49889

Here, the contribution margin is declining at a higher pace also the profitability of the line. The line should be discontinued.