Question

Building Your Skills Analytical Thinking (L07-4) Diversified Products, Inc., has recently acquired a small publishing company that offers three books for sale-a cookbook, a travel guide, and a handy speller. Each book sells for $15. The publishing company's most recent monthly income statement is shown below. Product line Total Travel Handy Company Cookbook Guide Speller $360,000 $114,000 $ 165,000 $81,000 Sales Expenses: Printing costs Advertising General sales Salaries Equipment depreciation Sales commissions General administration Warehouse rent Depreciation-office facilities Total expenses Net operating income (loss) 114,000 39,000 64,200 10,800 48,00 14,700 25,500 7,800 21,600 6,840 9,90 4,860 45,00 20,000 10,200 14,800 9,30 3,100 3,100 3,180 36,00 11,460 16,500 8,100 45,600 15,200 15, 2ee 15,200 14,40e 4,560 6,6ee 3,240 6,680 2,200 2,200 2,200 340,500 217,600 153,400 70, 100 $ 19,500 $ (3,600) 5 11,600 $ 10,900 The following additional information is available: a. Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the income statement above Sales commissions are 10% of sales. b. The same equipment is used to produce all three books, so the equipment depreciation expense has been allocated equally among the three product lines. An analysis of the company's activities Indicates that the equipment is used 25% of the time to produce cookbooks, 50% of the time to produce travel guides, and 25% of the time to produce handy spellers. c. The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is $3 per square foot per year. The warehouse contains 57,600 square feet of space, of which 9,600 square feet is used by the cookbook line, 26,400 square feet by the travel guide line, and 21,600 square feet by the handy speller line d. The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars. e. The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines. 1. All other costs are traceable to the three product lines in the amounts shown on the income statement above. The management of Diversified Products, Inc., is anxious to improve the publishing company's 6% return on sales Required: 1. Prepare a new contribution format segmented Income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional Information provided 2. Based on the segmented Income statements given in the problem, management plans to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide. However, based on the new contribution format segmented Income statement that you prepared a. Do you agree with management's plan to eliminate the cookbook? 0-1 Compute the contribution margin ratio for each product 0-2. Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide?

Answer 1

1.Segmented Income Statement

	Total Company	Cookbook	Travel Guide	Handy Speller
Sales	360,000	114,000	165,000	81,000
Less: Variable expenses
Printing costs	114,000	39,000	64,200	10,800
Sales Commissions	36,000	11,400	16,500	8,100
Contribution Margin	210,000	63,600	84,300	62,100
Less: Fixed costs
Advertising	48,000	14,700	25,500	7,800
Equipment Depreciation	9,300	2,325	4,650	2,325
Warehouse Rent	14,400	2,400	6,600	5,400
Total traceable fixed expenses	71,700	19,425	36,750	15,525
Segment Margin	138,300	44,175	47,550	46,575
Fixed expenses not traceable
General Sales	21,600
Salaries	45,000
General Administration	45,600
Depreciation-Office facilities	6,600
Net operating income	19,500

2a. No, as it is generating a segment margin of $44,175

b-1. Contribution margin for each product

	Total Company	Cookbook	Travel Guide	Handy Speller
Sales	360,000	114,000	165,000	81,000
Contribution Margin	210,000	63,600	84,300	62,100
Contribution Margin Ratio=Contribution Margin/Sales	58.33%	55.79%	51.09%	76.67%

b-2. No, since the contribution margin ratio is lowest for travel guide