Diego Company manufactures one product that is sold for $75 per unit in two geog
ID: 2459895 • Letter: D
Question
Diego Company manufactures one product that is sold for $75 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 46,000 units and sold 42,000 units.
The company sold 31,000 units in the East region and 11,000 units in the West region. It determined that $200,000 of its fixed selling and administrative expenses is traceable to the West region, $150,000 is traceable to the East region, and the remaining $38,000 is a common fixed cost. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.
12. If the company produces 4,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year 2?
13. Prepare a contribution format segmented income statement that includes a Total column and columns for the East and West regions.
14.Diego is considering eliminating the West region because an internally generated report suggests the region’s total gross margin in the first year of operations was $46,000 less than its traceable fixed selling and administrative expenses. Diego believes that if it drops the West region, the East region's sales will grow by 5% in Year 2. Using the contribution approach for analyzing segment profitability and assuming all else remains constant in Year 2, what would be the profit impact of dropping the West region in Year 2?
15. Assume the West region invests $36,000 in a new advertising campaign in Year 2 that increases its unit sales by 20%. If all else remains constant, what would be the profit impact of pursuing the advertising campaign?
Diego Company manufactures one product that is sold for $75 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 46,000 units and sold 42,000 units.
Explanation / Answer
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12. Absorption costing income will be lower than variable costing income. The variable costing income statement will only include the fixed manufacturing overhead costs incurred during the second year of operations, whereas the absorption costing cost of goods sold will include all of the fixed manufacturing overhead costs incurred during the second year of operations plus some of the fixed manufacturing overhead costs that were deferred in inventory at the end of the prior year.
13. The segment margins for the East and West regions are computed as follows:
Total
Company
East
West
Sales*.................................
$3,150,000
$2,325,000
$825,000
Variable expenses**..............
2,142,000
1,581,000
561,000
Contribution margin..............
1,008,000
744,000
264,000
Traceable fixed expenses.......
350,000
150,000
200,000
Region segment margin........
658,000
$594,000
$64,000
Common fixed expenses not traceable to regions
($644,000 + $38,000).........
682,000
Net operating loss..................
$(24,000)
*
**
East: 31,000 packs × $75 per pack = $2,325,000;
West: 11,000 packs × $75 per pack= $825,000.
East: 31,000 packs × $51 per pack = $1,581,000;
West: 11,000 packs × $51 per pack= $561,000.
14. Diego has apparently determined that the total gross margin in the West region equals $154,000. As computed in requirement 1, the unit product cost under absorption costing is $61; therefore the gross margin per unit is $14 ($75 – $61). The West region’s total gross margin of $154,000 (11,000 units × $14 per unit) is less than its traceable fixed expenses of $200,000. This mode of analysis creates the illusion that the West region should be discontinued.
The correct way to answer this question is to focus on the information in the contribution format segmented income statements as follows:
Forgone segment margin in the West region............................
$(64,000)
Additional contribution margin in East region*..........................
47,062.5
Decrease in profits if the West region is dropped.........................
$ (16,937.5)
* $941,250 × 5% = $47,062.5
15. The profit impact is computed as follows:
Additional advertising.......................................
$(36,000)
Additional contribution margin in the West region*..........................
52,800
Increase in profits...........................................
$ 16,800
* $264,000 × 20% = $52,800.
Total
Company
East
West
Sales*.................................
$3,150,000
$2,325,000
$825,000
Variable expenses**..............
2,142,000
1,581,000
561,000
Contribution margin..............
1,008,000
744,000
264,000
Traceable fixed expenses.......
350,000
150,000
200,000
Region segment margin........
658,000
$594,000
$64,000
Common fixed expenses not traceable to regions
($644,000 + $38,000).........
682,000
Net operating loss..................
$(24,000)
*
**
East: 31,000 packs × $75 per pack = $2,325,000;
West: 11,000 packs × $75 per pack= $825,000.
East: 31,000 packs × $51 per pack = $1,581,000;
West: 11,000 packs × $51 per pack= $561,000.
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