Contribution Income Statement for Profit Centers; Strategy, International Stratford Corporation is a diversified company whose products are marketed both domestically and internationally. Its major product lines are pharmaceutical products, sports equipment, and household appliances. At a recent meeting, Stratford’s board of directors had a lengthy discussion on ways to improve overall corporate profitability without new acquisitions. New acquisitions are problematic because the company already has a lot of debt. The board members decided that they needed additional financial information about individual corporate operations to target areas for improvement. Dave Murphy, Stratford’s controller, has been asked to provide additional data to assist the board in its investigation. Stratford is not a public company and, therefore, has not prepared complete income statements by product line. Dave has regularly prepared an income statement by product line through contribution margin. However, he now believes that income statements prepared through operating income along both product lines and geographic areas would provide the directors with the required insight into corporate operations. Dave has the following data available:
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| Product Lines |
|
| ||
| Pharmaceutical | Sports | Appliances | Total |
| |
Production/Sales in units | 160,000 | 180,000 | 160,000 | 500,000 |
| |
Average selling price per unit | $8.00 | $20.00 | $15.00 |
|
| |
Average variable manufacturing cost per unit | 4.00 | 9.50 | 8.25 |
|
| |
Average variable selling expense per unit | 2.00 | 2.50 | 2.25 |
|
| |
Fixed factory overhead excluding depreciation |
|
|
| $500,000 |
| |
Depreciation of plant and equipment |
|
|
| 400,000 |
| |
Administrative and selling expense |
|
|
| 1,160,000 |
| |
Dave had several discussions with the division managers from each product line and compiled this
information:
• The division managers concluded that Dave should allocate fixed factory overhead on the basis of the ratio of the variable costs per product line or per geographic area to total variable costs.
• Each division manager agreed that a reasonable basis for the allocation of depreciation on plant and equipment would be the ratio of units produced per product line or per geographic area to the total number of units produced.
• There was little agreement on the allocation of administrative and selling expenses, so Dave decided to allocate only those expenses that were directly traceable to the SBU that is, manufacturing staff salaries to product lines and sales staff salaries to geographic areas. He used these data for this allocation:
Manufacturing | Staff | Sales Staff |
|
Pharmaceutical | $120,000 | United States | $ 60,000 |
Sports | 140,000 | Canada | 100,000 |
Appliances | 80,000 | Europe | 250,000 |
• The division managers provided reliable sales percentages for their product lines by geographic area:
| Percentage of Unit Sales |
|
|
| United States | Canada | Europe |
Pharmaceutical | 40% | 10% | 50% |
Sports | 40 | 40 | 20 |
Appliances | 20 | 20 | 60 |
Dave prepared this product-line income statement:
STRATFORD CORPORATION Statement of Income by Product Lines For the Fiscal Year Ended April 30, 2010 | ||||||
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| Product Lines |
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|
| |
| Pharmaceutical | Sports | Appliances | Unallocated | Total | |
Sales in units | 160,000 | 180,000 | 160,000 |
| 500,000 | |
Sales | $1,280,000 | $3,600,000 | $2,400,000 | — | $7,280,000 | |
Variable manufacturing |
|
|
|
|
| |
and selling costs | 960,000 | 2,160,000 | 1,680,000 | — | 4,800,000 | |
Contribution margin | $ 320,000 | $1,440,000 | $ 720,000 | — | $2,480,000 | |
Fixed costs |
|
|
|
|
| |
Fixed factory overhead | $ 100,000 | $ 225,000 | $ 175,000 | — | $500,000 | |
Depreciation | 128,000 | 144,000 | 128,000 | — | 400,000 | |
Administrative and |
|
|
|
|
| |
selling expense | 120,000 | 140,000 | 80,000 | $ 820,000 | 1,160,000 | |
Total fixed costs | $ 348,000 | $ 509,000 | $ 383,000 | $ 820,000 | $2,060,000 | |
Operating income (loss) | $ (28,000) | $ 931,000 | $ 337,000 | $(820,000) | $ 420,000 | |
Required
1. Prepare a contribution income statement for Stratford Corporation based on the company’s geographic areas of sales.
2. As a result of the information disclosed by both income statements (by product line and by geographic area), recommend areas on which Stratford Corporation should focus its attention to improve corporate profitability.
3. What changes would you make to Stratford’s strategic performance measurement system? Include the role, if any, of the firm’s international business operations in your response.
(CMA Adapted)
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