Question

Diversified Products, Inc., has recently acquired a small publishing company that offers three books for sale—a cookbook, a travel guide, and a handy speller. Each book sells for $13. The publishing company’s most recent monthly income statement is shown below.

				Product line
	Total Company			Cookbook					Travel Guide			Handy Speller
Sales	$	360,000		$	130,000			$	170,000		$	60,000
Expenses:
Printing costs		119,000			44,000				70,000			5,000
Advertising		42,000			21,000				18,000			3,000
General sales		21,600			7,800				10,200			3,600
Salaries		34,000			19,000				10,700			4,300
Equipment depreciation		10,800			3,600				3,600			3,600
Sales commissions		36,000			13,000				17,000			6,000
General administration		47,100			15,700				15,700			15,700
Warehouse rent		14,400			5,200				6,800			2,400
Depreciation—office facilities		8,100			2,700				2,700			2,700
Total expenses		333,000			132,000				154,700			46,300
Net operating income (loss)	$	27,000		$	(2,000	)		$	15,300		$	13,700

The following additional information is available:

1. Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the income statement above. Sales commissions are 10% of sales.

2. The same equipment is used to produce all three books, so the equipment depreciation cost has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 25% of the time to produce cookbooks, 50% of the time to produce travel guides, and 25% of the time to produce handy spellers.

3. The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is $3 per square foot per year. The warehouse contains 57,600 square feet of space, of which 10,600 square feet is used by the cookbook line, 27,400 square feet by the travel guide line, and 19,600 square feet by the handy speller line.

4. The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars.

5. The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines.

6. All other costs are traceable to the three product lines in the amounts shown on the income statement above.

The management of Diversified Products, Inc., is anxious to improve the publishing company’s 5% return on sales.

Required:

1. Prepare a new contribution format segmented income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional information provided.

2. Based on the segmented income statements given in the problem, management plans to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide. However, based on the new contribution format segmented income statement that you prepared:

a. Do you agree with management's plan to eliminate the cookbook?

b-1. Compute the contribution margin ratio for each product.

b-2. Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide?

Answer 1

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Part 1
		Total Company	Cook-book	Travel Guide	Handy Speller
Sales		$                  360,000	$        130,000	$          170,000	$                60,000
Variable expenses:
Printing cost		$                  119,000	$          44,000	$             70,000	$                  5,000
Sales commissions		$                    36,000	$          13,000	$             17,000	$                  6,000
Total variable expenses		$                  155,000	$          57,000	$             87,000	$                11,000
Contribution margin		$                  205,000	$          73,000	$             83,000	$                49,000
Traceable fixed expenses:
Advertising		$                    42,000	$          21,000	$             18,000	$                  3,000
Salaries		$                    34,000	$          19,000	$             10,700	$                  4,300
Equipment depreciation	$10,800*25%,50%,25%	$                    10,800	$             2,700	$               5,400	$                  2,700
Warehouse rent	($3*Sq Feet)/12	$                    14,400	$             2,650	$               6,850	$                  4,900
Total traceable fixed expenses		$                  101,200	$          45,350	$             40,950	$                14,900
Product line segment margin		$                  103,800	$          27,650	$             42,050	$                34,100
Common fixed expenses:
General sales		$                    21,600
General administration		$                    47,100
Depreciation—office facilities		$                       8,100
Total common fixed expenses		$                    76,800
Net operating income		$                    27,000
Part 2a	No, since it is giving contribution of $73,000 and produc line margin of $103,800
Part 2b1
			Cook-book	Travel Guide	Handy Speller
Sale	a		$        130,000	$          170,000	$                60,000
Cont Margin	b		$          73,000	$             83,000	$                49,000
CM Ratio	a/b		56.15%	48.82%	81.67%
Part 2b2
It is probably unwise to focus all available resources on promoting the travel guide
The travel guide has the lowest contribution margin ratio of the three products
Therefore, a dollar of sales of the travel guide generates less profit than a dollar of sales of either of the two other products