Question

AudioMart is a retailer of radios, stereos, and televisions. The store carries two portable sound systems that have radios, tape players, and speakers. System A, of slightly higher quality than System B, costs $19 more. With rare exceptions, the store also sells a headset when a system is sold. The headset can be used with either system. Variable-costing income statements for the three products follow:

	System A	System B	Headset
Sales	$ 45,500	$ 32,600	$ 7,900
Less: Variable expenses	20,400	25,600	3,400
Contribution margin	$25,100	$7,000	$4,500
Less: Fixed costs *	9,800	17,900	2,700
Operating income (loss)	$15,300	$(10,900)	$1,800

* This includes common fixed costs totaling $17,900, allocated to each product in proportion to its revenues.

The owner of the store is concerned about the profit performance of System B and is considering dropping it. If the product is dropped, sales of System A will increase by 31%, and sales of headsets will drop by 26%. Round all answers to the nearest whole number.

	Required:
1.	Prepare segmented income statements for the three products using a better format.
2.	CONCEPTUAL CONNECTION: Prepare segmented income statements for System A and the headsets assuming that System B is dropped. Should B be dropped?
3.	CONCEPTUAL CONNECTION: Suppose that a third system, System C, with a similar quality to System B, could be acquired. Assume that with C the sales of A would remain unchanged; however, C would produce only 80% of the revenues of B, and sales of the headsets would drop by 10%. The contribution margin ratio of C is 50%, and its direct fixed costs would be identical to those of B. Should System B be dropped and replaced with System C?

Refer to the list below for the exact wording of an amount description within your income statement.

Amount Descriptions
Add: Common fixed cost
Add: Direct fixed cost
Add: Variable expenses
Contribution margin
Less: Common fixed cost
Less: Direct fixed cost
Less: Variable expenses
Operating income
Operating loss
Sales
Segment margin

1. Prepare segmented income statements for the three products. Refer to the list of Amount Descriptions for the exact wording of text items within your income statement. Round your answers to the nearest dollar. Input expenses as positive numbers.

AudioMart

Segmented Income Statement

System A, System B, and Headset

1		System A	System B	Headset	Total
2
3
4
5
6
7
8

2(a) Prepare segmented income statements for System A and the headsets assuming that System B is dropped. Refer to the list of Amount Descriptions for the exact wording of text items within your income statement. Round your answers to the nearest dollar. Input expenses as positive numbers. (Note: Be sure to complete 2(b) below the statement.)

AudioMart

Segmented Income Statement

System A and Headset

1		System A	Headset	Total
2
3
4
5
6
7
8

2(b) Should system B be dropped?

No

Yes

Suppose that a third system, System C, with a similar quality to System B, could be acquired. Assume that with C the sales of A would remain unchanged; however, C would produce only 80% of the revenues of B, and sales of the headsets would drop by 10%. The contribution margin ratio of C is 50%, and its direct fixed costs would be identical to those of B.

3(a) Prepare segmented income statements for System A, System C and the headsets. Refer to the list of Amount Descriptions for the exact wording of text items within your income statement. Round your answers to the nearest dollar. Input expenses as positive numbers. (Note: Be sure to complete 3(b) below the statement.)

AudioMart

Segmented Income Statement

System A, System C, and Headset

1		System A	System C	Headset	Total
2
3
4
5
6
7
8

3(b) Should System B be dropped and replaced with System C?

The best option is to   .

Yes

Answer 1

Part 1
		System A	System B	Headset	Total
	Sales	$                       45,500	$                       32,600	$               7,900	$           86,000
	Less:Variable expenses	$                       20,400	$                       25,600	$               3,400	$           49,400
	Contribution margin	$                       25,100	$                         7,000	$               4,500	$           36,600
	Less:Direct Fixed Costs	$                            330	$                       11,115	$               1,056	$           12,500
	Segment Margin	$                       24,770	$                        -4,115	$               3,444	$           24,100
	Less:Common Fixed Costs	$                         9,470	$                         6,785	$               1,644	$           17,900
	Operating Income	$                       15,300	$                      -10,900	$               1,800	$             6,200
Part 2		System A	Headset	Total
	Sales	$                       59,605	$                         5,846	$             65,451
	Less:Variable expenses	$                       26,724	$                         2,516	$             29,240
	Contribution margin	$                       32,881	$                         3,330	$             29,551
	Less:Direct Fixed Costs	$                            330	$                         1,056	$               1,385
	Segment Margin	$                       32,551	$                         2,274	$             34,826
	Less:Common Fixed Costs	$                       16,301	$                         1,599	$             17,900
	Operating Income	$                       16,250	$                            675	$             16,926
	Since the dropping of System B has increased the Operating income hence System B should be dropped.
Part 3		System A	System C	Headset	Total
	Sales	$                       45,500	$                       26,080	$               7,110	$           78,690
	Less:Variable expenses	$                       20,400	$                       13,040	$               3,060	$           36,500
	Contribution margin	$                       25,100	$                       13,040	$               4,050	$           42,190
	Less:Direct Fixed Costs	$                            330	$                       11,115	$               1,056	$           12,500
	Segment Margin	$                       24,770	$                         1,925	$               2,994	$           29,690
	Less:Common Fixed Costs	$                       10,350	$                         5,933	$               1,617	$           17,900
	Operating Income	$                       14,420	$                        -4,007	$               1,377	$           11,790
	System C should be introduced in place of System B as it increases the Operating Income