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 $15. The publishing company’s most recent monthly income statement is shown below.

				Product line
	Total Company			Cookbook					Travel Guide			Handy Speller
Sales	$	370,000		$	140,000			$	174,000		$	56,000
Expenses:
Printing costs		121,000			46,000				71,000			4,000
Advertising		50,000			29,000				19,000			2,000
General sales		22,200			8,400				10,440			3,360
Salaries		36,000			18,500				13,000			4,500
Equipment depreciation		11,400			3,800				3,800			3,800
Sales commissions		37,000			14,000				17,400			5,600
General administration		45,300			15,100				15,100			15,100
Warehouse rent		14,800			5,600				6,960			2,240
Depreciation—office facilities		8,700			2,900				2,900			2,900
Total expenses		346,400			143,300				159,600			43,500
Net operating income (loss)	$	23,600		$	(3,300	)		$	14,400		$	12,500

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 35% of the time to produce cookbooks, 50% of the time to produce travel guides, and 15% 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 59,200 square feet of space, of which 11,000 square feet is used by the cookbook line, 27,800 square feet by the travel guide line, and 20,400 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

solution: 1) Total Company 370,000 Cookbook 140,000 Travel Guide 174,000 Handy speller 56,000 Sales Variable expenses: Printing cost sales comission 121,000 37,000 46,000 14,000 71,000 17,400 4,000 5,600 9,600 158,000 212,000 60,000 80,000 88,400 85,600 46,400 Total variable expense Contribution margin Trace able fixed expenses equipment de preciation* warehouse rent ** salaries Advertising 5,700 6,950 11,400 14,800 36,000 50,000 3,990 2,750 18,500 29,000 1,710 5,100 4,500 2,000 13,000 19,000 112,200 99,800 54,240 25,760 44,650 40,950 13,310 33,090 Total traceable fixed expense Product line segment margin Common fixed expenses General sales General administration Depreciation - office facilities 22,200 45,300 8,700 Total common fixed expense Net operating income 76,200 23,600 working: *equipment depreciation Cookbook Travel Guide Handy speller calculation 11400*0.35 11400*0.5 11400*0.15 3,990 5,700 1,710 **warehouse rent Cookbook Travel Guide Handy speller calculation (14800/59200) *11000 (14800/59200) *27800 (14800/59200) *20400 2,750 6,950 5,100

2a) No (as segment margin is positive) b-1 Contribution margin / Sales contribution margin ratio = Contribution margin/sales Cookbook 80,000 140,000 57% Travel Guide Handy speller 85,600 46,400 174,000 56,000 49% 83% | 6-2 No (as contribution margin ratio of Travel guide is lowest).