Question

Hello I need a detailed solution for part a (with calculation)
Agnew Manufacturing produces and sells three models of a single product, Standard, Superior, and DeLuxe, in a local market and in a regional market. At the end of the first quarter of the current year, the following income statement in thousands of dollars) has been prepared. Total Local Regional Sales revenue $7,800 $6,000 $1,800 Cost of goods sold 6,060 4,650 1,410 Gross margin $1,740 $1,350 $ 390 Marketing costs 630 360 270 Administrative costs 312 240 72 Total marketing and administrative $ 942 $ 600 $ 342 Operating profits $ 798 $ 750 $ 48 Management has expressed special concern with the regional market because of the extremely poor return on sales. This market was entered a year ago because of excess capacity. It was originally believed that the return on sales would improve with time, but after a year, no noticeable improvement can be seen from the results as reported in the preceding quarterly statement. In attempting to decide whether to eliminate the regional market, the following information has been gathered. Sales revenue Variable manufacturing costs as a percentage of sales revenue Variable marketing costs as a percentage of sales revenue Products Standard Superior $3,000 $2,400 60% 70% 3 2 DeLuxe $2,400 60% 2
Hello I need a detailed answer for part a (with calculations

Answer 1

Differential cost is arrived after reducing the cost of product that is to be dropped from the total cost. In this case, Local market cost and sales i.e. literally income statement needs to be reduced from total market.

                                                                                                                                (Amount in ‘000)

	a	b	a-b
Particulars	Total	Local market	Difference i.e. Regional market
Sales revenue	$                 7,800.00	$          6,000.00	$             1,800.00
Less: Cost of goods sold	$ 6 ,060.00	$         4,650.00	$             1,410.00
Gross margin (A)	$                  740.00	$          350.00	$        390.00
Variable marketing cost	$                    186.00	$             144.00	$           42.00
Fixed marketing costs	$                 444.00	$         444.00	$    -
Fixed administrative cost	$                312.00	$              12.00	$           -
Total marketing and admin cost (B)	$               942.00	$         900.00	$        42.00
Operating profit (A- B)	$                   798.00	$              50.00	$                348.00

The regional market shall not be dropped as regional market is still able to contribute towards own variable cost and separate fixed costs along with common fixed costs to the extent of $ 348,000.

Working notes :

Computation of variable marketing costs as:

Variable marketing costs for Standard is 3%, Superior is 2% and Deluxe is also 2%.

To compute marketing cost, sales by markets need to be used which is given in last table in the question

	Local market	Regional market	Total market
Standard	72 (2400*3%)	18 (600*3%)	$            90.00
Superior	36 (1800*2%	12 (600*2%)	$          48.00
Deluxe	36 (1800*2%	12 (600*2%)	$          48.00
Total	$                     144.00	$                42.00	$         186.00

The marketing cost is divided into fixed and variable component as :

Total marketing cost = 630 as given

Variable marketing cost = 186

Fixed marketing cost = 630 – 186 = $ 444

Alternatively, this can be also computing using the sales of regional market and accounting for differential as:

Particulars	Standard	Superior	Deluxe	Total
Sales	600	600	600	1800
Less: variable manufacturing cost	360 (600*60%)	420 (600*70%)	360 (600*60%)	1140
Less: variable marketing costs	18 (600*3%)	12 (600*2%)	12 (600*2%)	42
Less: separate fixed cost of regional markets				270
Contribution towards fixed cost				348

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