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 $12. The publishing company’s most recent monthly income statement is shown below.

				Product line
	Total Company			Cookbook					Travel Guide			Handy Speller
Sales	$	355,000		$	125,000			$	168,000		$	62,000
Expenses:
Printing costs		118,000			43,000				66,000			9,000
Advertising		38,000			19,100				17,500			1,400
General sales		21,300			7,500				10,080			3,720
Salaries		33,000			18,000				10,600			4,400
Equipment depreciation		10,500			3,500				3,500			3,500
Sales commissions		35,500			12,500				16,800			6,200
General administration		46,800			15,600				15,600			15,600
Warehouse rent		14,200			5,000				6,720			2,480
Depreciation—office facilities		7,800			2,600				2,600			2,600
Total expenses		325,100			126,800				149,400			48,900
Net operating income (loss)	$	29,900		$	(1,800	)		$	18,600		$	13,100

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 expense has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 20% of the time to produce cookbooks, 45% of the time to produce travel guides, and 35% 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 56,800 square feet of space, of which 10,400 square feet is used by the cookbook line, 27,200 square feet by the travel guide line, and 19,200 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 4% 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

Segmented Income Statement
	Total Company	Cookbook	Travel Guide	Handy Speller
Sales	355,000	125,000	168,000	62,000
Less: Variable expenses
Printing costs	118,000	43,000	66,000	9,000
Sales Commissions	35,500	12,500	16,800	6,200
Contribution Margin	201,500	69,500	85,200	46,800
Lesse: Fixed costs
Advertising	38,000	19,100	17,500	1,400
Equipment Depreciation	10,500	2,100	4,725	3,675
Warehouse Rent	14,200	2,600	6,800	4,800
Total traceable fixed expenses	62,700	23,800	29,025	9,875
Segment Margin	138,800	45,700	56,175	36,925
Fixed expenses not traceable
General Sales	21,300
Salaries	33,000
General Administration	46,800
Depreciation-Office facilities	7,800
Net operating income	29,900
2a. No, as it is generating a segment margin pf $45,700
b-1 CM Ratio = CM/Sales	56.76%	55.60%	50.71%	75.48%
b-2 No, since the contribution margin ratio is lowest for travel guide