Question

Severo S.A. of Sao Paulo, Brazil, is organized into two divisions. The company’s contribution format segmented income statement (in terms of the Brazilian currency, the real, R) for last month is given below:

	Divisions
	Total Company			Cloth			Leather
Sales	R	1,770,700		R	2,050,000		R	1,640,000
Variable expenses		3,690,000			970,000			800,700
Contribution margin		1,919,300			1,080,000			839,300
Traceable fixed expenses:
Advertising		623,000			310,000			313,000
Selling and administrative		438,000			220,000			218,000
Depreciation		231,000			116,000			115,000
Total traceable fixed expenses		1,292,000			646,000			646,000
Divisional segment margin		627,300		R	434,000		R	193,300
Common fixed expenses		391,000
Operating income	R	236,300

   

Top management can’t understand why the Leather Division has such a low segment margin when its sales are only 20% less than sales in the Cloth Division. As one step in isolating the problem, management has directed that the Leather Division be further segmented into product lines. The following information is available on the product lines in the Leather Division:

	Leather Division Product Lines
	Garments			Shoes			Handbags
Sales	R	510,000		R	710,000		R	420,000
Traceable fixed expenses:
Advertising	R	81,000		R	113,000		R	119,000
Selling and administrative	R	31,000		R	36,000		R	40,000
Depreciation	R	20,000		R	57,000		R	38,000
Variable expenses as a percentage of sales		65	%		30	%		61	%

Analysis shows that R111,000 of the Leather Division’s selling and administrative expenses are common to the product lines.

Required:

1.	Prepare a contribution format segmented income statement for the Leather Division, with segments defined as product lines.

     

2.	Management is surprised by the handbag product line’s poor showing and would like to have the product line segmented by market. The following information is available about the markets in which the handbag line is sold:

	Handbag Markets
	Domestic			Foreign
Sales	R	210,000		R	210,000
Traceable fixed expenses:
Advertising	R	41,000		R	78,000
Variable expenses as a percentage of sales		40	%		82	%

	All of the handbag product line’s selling and administrative expenses and depreciation are common to the markets in which the product is sold. Prepare a contribution format segmented income statement for the handbag product line with segments defined as markets.

3.

Refer to the statement prepared in (1) above. The sales manager wants to run a special promotional campaign on one of the product lines over the next month. A marketing study indicates that such a campaign would increase sales of the Garments product line by R201,000 or sales of the shoes product line by R146,000. The campaign would cost R31,000.

a.	Compute the increased operating income for these product lines for the expected increased sales.

         

b.	Based on the above results, which product line should be chosen?
	Garments Shoes

Answer 1

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