Question

help me solve 2&3
Keep-Or-Drop Decision, Alternatives, Relevant Costs Reshier Company makes three types of rug shampooers. Model 1 is the basic model rented through hardware stores and supermarkets. Model 2 is a more advanced model with both dry-and wet-vacuuming capabilities. Model 3 is the heavy-duty riding shampooer sold to hotels and convention centers. A segmented income statement is shown below. Model 1 Model 2 Model 3 Total Sales $225,000 (99,000) Less variable costs of goods sold $578,000 (162,760) (36,500) $618,500 (349,200) (21,000) $1,421,500 (610,960) (63,100) $747,440 Less commissions (5,600) Contribution margin $120,400 $378,740 $248,300 Less common fixed expenses: Fixed factory overhead Fixed selling and administrative (375,000) (287,000) $85,440 Operating income While all models have positive contribution margins, Reshier Company is concerned because operating income is less than 10 percent of sales and is low for this type of company. The company's controller gathered additional information on fixed costs to see why they were so high. The following information on activities and drivers was gathered: Driver Usage by Model Activity Activity Cost Activity Driver Model 1 Model 2 Model 3 Engineering $77,000 Engineering hours 710 74 216

Answer 1

I'm taking values from your calculations. The calculations are perfectly right but your analysis are wrong. Will show it.

2)

In this requirement the company is planning to drop Model 1 segment because it shows an negative operating income.

Now lets assume that company drops Model 1.

So the contribution amounts to $120,400 is no longer available to the company. Which means the lost it completely.

Let's take it as lost contribution = $120,400.

Now think company has fixed cost of $77,000 in engineering cost, by dropping Model 1 does company avoided any of this cost? No.

So there is no avoidable fixed cost.

In setup cost company has $196,000 and once again company can't avoid any of it.

So here also company doesn't have any avoidable fixed costs.

Company has equipment rental cost of $24,500 which is avoidable. Means if company drops Model 1 then there is no more equipment rental cost.

So the Avoidable fixed cost is $24,500

Company have $105,000 in customer service costs and are not avoidable.

So in conclusion by dropping Model 1:-

Lost Contribution = $120,400 -

Avoidable Fixed cost = $24,500

So by dropping Model 1 we will loss total operating income of $(120,400-$24,500) = $95,900.

Now let's see what will be our operating income if we drop Model 1 and prove that our calculations are right.

Total contribution margin = $627,040

($747,440-$120,400)

Total Engineering cost = $ 77,000

Total Setup Cost = $196,000

Equipment Rental = $ 0

Total customer service = $105,000

Cost

Factory Overhead = $77,500

Selling & admin. Exp = $182,000

Operating Income = ($10,460)

Now let's see the difference between these two operating income

Operating Income With Model 1 = $85,440

Operating Income without Model 1= ($10,460)

$85,440-(-$10,460) = $95,900

Now it's proved.

3)

In this requirement Company can avoid some of its fixed cost related to engineering costs and set up cost. Now lets do the calculations.

Our lost contribution reamains the same = $120,400

Avoidable fixed costs:-

Equipment rental = $24,500

Avoidable engineering cost:-

Total engineering cost allocated to Model 1 is $54,670. Total engineering hr is 710

So the per hr rate is $54,670/710 = $77/Hr

from engineering hrs company can avoid 190hrs.

So the avoidable engineering cost = (190*$77) = $14,630

Avoidable setup cost:-

Total setup cost allocated to Model 1 = $46,997

Total setup hrs is 13,000

so the per hr rate = $46,997/13,000

= $3.6151538461538

Avoidable setup hrs is 4,900hr

So the avoidable setup cost = 4,900*$3.6151538461538 = $17,715

Total avoidable cost :-

Equipment Rental = $24,500

Engineering cost = $14,630

Setup cost = $17,715

Total avoidable cost = $56,845

So if we drop Model 1 Under this situation:-

Lost contribution = $120,400

Avoidable Fixed cost = $56,845

We will have a loss of = $63,555

This alternative is more cost benefit because

Under 1st alternative we had loss of= ($95,900)

Under this alternative we had loss of

only = ($63,555)

So this is most cost effective by ($95,900-$63555) = $32,345