Question

Diego Company manufactures one product that is sold for $75 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 57,000 units and sold 52,000 units.

25 18 Variable costs per unit: Manufacturing: Direct materials Direct labor Variable manufacturing overhead Variable selling and administrative Fixed costs per year: Fixed manufacturing overhead Fixed selling and administrative expense visuus $ 627,000 $ 645,000

The company sold 36,000 units in the East region and 16,000 units in the West region. It determined that $310,000 of its fixed selling and administrative expense is traceable to the West region, $260,000 is traceable to the East region, and the remaining $75,000 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.

Questions:

1) What is the company’s net operating income (loss) under absorption costing?

2) What is the amount of the difference between the variable costing and absorption costing net operating incomes (losses)?

3) Prepare a contribution format segmented income statement that includes a Total column and columns for the East and West regions.

5) 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 $22,000 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?

6) Assume the West region invests $47,000 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

The fixed manufacturing overhead is absorbed as product cost under absorption costing while it is charged as a period cost under variable costing
1.Net Operating income uncer absorption costing = (75-25-18-3-627000/57000)*52000 - 5*52000-645000
=$31,000
2.Difference between income = Difference in units Produced and sold*Fixed manufacturing overhead per unit
=5000*(627000/57000)
i.e.	55000
Contribution format Income Statement
	Total Company	East	West
Sales Revenue	3,900,000	2,700,000	1,200,000
Less: Variable costs	2,652,000	1,836,000	816,000
Contribution Margin	1,248,000	864,000	384,000
Less: Traceable Fixed costs	570,000	260,000	310,000
Segment Margin	678,000	604,000	74,000
Less: Common Fixed costs	702,000
Operating Income	-24,000
5
Contribution format Income Statement
	East
Sales Revenue	2,835,000
Less: Variable costs	1,927,800
Contribution Margin	907,200
Less: Traceable Fixed costs	260,000
Segment Margin	647,200
Less: Common Fixed costs	702000
Operating Income	-54,800
Profits will reduce by 30,800
6
Profit impact = Increase in CM - cost of campaign
=384000*20% - 47000
Profits will increase by	29,800