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 Travel Handy Company Cookbook Guide Speller $370,000 $140,000 $174,000 $56,000 Sales Expenses : Printing costs Advertising General sales Salaries 121,000 50,000 22,200 36,000 11,400 46,000 29,000 8,400 18,500 3,800 71,000 19,000 10,440 13,000 3,800 4,000 2,000 3,360 4,500 3,800 Equipment depreciation 37,000 14,000 17,400 5,600 45,300 14,800 15, 100 5,600 15,100 15,100 6,960 2,240 Sales . commissions General administration Warehouse rent Depreciation- office facilities Total expenses Net operating income (loss) 8,700 2,900 2,900 2,900 346,400 143,300 159,600 43,500 $ 23,600 $ (3,300) $ 14,400 $12,500 The following additional information is available: a. 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. b. 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 35% of the time to produce cookbooks, 50% of the time to produce travel guides, and 15% of the time to produce handy spellers. C. 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. d. 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. e. 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. f. 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

1.

.

Contribution margin Income statement segment wise

Diversified Products, Inc.

.	Total Company	Cookbook	Travel Guide	Handy Speller
Sales	370000	140000	174000	56000
Variable Expenses
Printing costs	1,21,000	46,000	71,000	4,000
Sales commissions	37,000	14,000	17,400	5,600
Total variable cost	1,58,000	60000	88400	9600
Segment Contribution Margin	212000	80000	85600	46400
Traceable Fixed Expenses
Advertising	50,000	29,000	19,000	2,000
Salaries	36,000	18,500	13,000	4,500
Equipment depreciation	11,400	3,990	5,700	1,710
Warehouse rent	14,800	2,750	6,950	5,100
Total Traceable Fixed Expenses	112200	54240	44650	13310
Segment Margin	99800	25760	40950	33090
General fixed expense not tracable to products
Depreciation - office facilities	8,700
General administration	45,300
General sales	22,200
Net operating income (loss)	23600

Equipment depreciation

To cook book = 11400 * 35% = 3990

To Travel Guide = 11400 * 50% = 5700

To Handy Speller = 11400 * 15% = 1710

.

Warehouse rent

To cook book = 14800* 11000 / 59200 = 2750 or ( 3 * 11000 ) / 12

To Travel Guide = 14800* 27800 / 59200 = 6950

To Handy Speller = 11400 * 20400 / 59200 = 5100

.

2.

.

a. - No, I do not agree with the decision as the company will lose the segment margin of $25,760 and will not be able to avoid any of the non-traceable fixed costs.

b1. -

.	Total Company	Cookbook	Travel Guide	Handy Speller
Sales	370000	140000	174000	56000
Variable Expenses
Printing costs	121000	46000	71000	4000
Sales commissions	37000	14000	17400	5600
Total variable cost	158000	60000	88400	9600
Segment Contribution Margin	212000	80000	85600	46400
Contribution Margin Ratio	57.30%	57.14%	49.20%	82.86%

Contribution Margin Ratio = Segment Contribution Margin / Sales

.

b2. - No, I think the marketing effort should be focused on the handy speller as it has the highest contribution margin ratio, meaning that for any additional sales dollar, it will contribute the most towards covering fixed costs and generating profit.