Diego Company manufactures one product that is sold for $76 per unit in two geog

Question

Diego Company manufactures one product that is sold for $76 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 58,000 units and sold 54,000 units. Variable costs per unit: Manufacturing: Direct materials $ 23 Direct labor $ 15 Variable manufacturing overhead $ 3 Variable selling and administrative $ 3 Fixed costs per year: Fixed manufacturing overhead $ 1,160,000 Fixed selling and administrative expenses $ 640,000 ________________________________________ The company sold 40,000 units in the East region and 14,000 units in the West region. It determined that $320,000 of its fixed selling and administrative expenses is traceable to the West region, $270,000 is traceable to the East region, and the remaining $50,000 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. 1. What is the unit product cost under variable costing? 2. What is the unit product cost under absorption costing? 3. What is the company’s total contribution margin under variable costing? 4. What is the company’s net operating income (loss) under variable costing? 5. What is the company’s total gross margin under absorption costing? 6. What is the company’s net operating income (loss) under absorption costing? 7. What is the amount of the difference between the variable costing and absorption costing net operating incomes (losses)? 8. A. What is the company’s break-even point in unit sales? B. Is it above or below the actual sales volume? 9. If the sales volumes in the East and West regions had been reversed, what would be the company’s overall break-even point in unit sales? 10. What would have been the company’s variable costing net operating income (loss) if it had produced and sold 54,000 units? 11. What would have been the company’s absorption costing net operating income (loss) if it had produced and sold 54,000 units? 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 $110,000 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 4% 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? The profit will ____ by ____ 15. Assume the West region invests $48,000 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? The profit will ____ by _____

Explanation / Answer

1) Unit Product cost under Variable Costing: direct materials 23 direct labor 15 variable manufacturing OH 3 Unit product cost - $ 41 2) Unit product cost under absorption costing: direct materials 23 direct labor 15 variable manufacturing OH 3 fixed manufacturing OH 20 (1160000/58000) Unit product cost - $ 61 3) Total contribution margin under variable costing: Sales (54000*76) 4104000 Less: Variable cost of goods sold: beginning inventory 0 add: cost of goods manufactured (58000*41) 2378000 cost of goods available for sale 2378000 less: ending inventory (4000*41) 164000 2214000 gross contribution margin 1890000 less variable selling and admn (54000*3) 162000 contribution margin 1728000 4) Net Income (Loss) under variable costing: contribution margin (as above) 1728000 less: fixed costs: manufacturing 1160000 selling and administrative 640000 1800000 net loss -72000 5) Total gross margin under absorption costing: Sales 4104000 less: cost of goods sold: beginning inventory 0 add: cost of goods manufactured (58000*61) 3538000 cost of goods available for sale 3538000 less: ending inventory (4000*61) 244000 3294000 gross margin 810000 6) Net operating income under absorption costing: gross margin (as above) 810000 less: selling and admn exps: variable 162000 fixed 640000 802000 net income 8000 7) Difference in the reported income and loss = 8000 - (-) 72000 = $80,000 The difference is due to the difference in the value of ending inventory. Under absorption costing it is more by $80000, which is the difference. 8) A) BEP in units: is given by the formula - Fixed costs/contribution margin per unit 1800000/(76-41) = 51428.57 = 51429 units. 8) B) The BEP is below the actual sales volume of 54000 units 9) There will not be any change in the BEP in unit sales. It would be the same 51429 units. 10) It would have been the same -$72000. as cost of goods sold would be the same as for 58000 units. 11) It would have been the same as loss under variable costing at -$72000. Revised working: Sales 4104000 less: cost of goods sold: beginning inventory 0 add: cost of goods manufactured (58000*62.48 3373920 cost of goods available for sale 3373920 less: ending inventory 0 3373920 gross margin 730080 less: selling and admn exps: variable 162000 fixed 640000 802000 net income -71920 rounding off difference -80 net loss -72000 Note: where there is no opening or closing stock the net income under both the methods would be the same. 12) If the company produces 4000 units less than it sells in the second year, the absorption costing net income would be less than the net income under variable costing net income as it will have more fixed expenses debited to the income statement-- 2nd years' full fixed expenses (no portion of which is carried over to the 3rd year due to absence of closing stock) plus the fixed expenses of the 1st year loaded on to the closing stock of the first year which becomes the expense of the second year. Thus under absorption costing more than 1 years fixed cost would be charged to the income statement. Under variable costing only the current years fixed expenses would be charged to the income statement. 13) Segmented income statement under variable costing: Total East West units sold 54000 40000 14000 sales 4104000 3040000 1064000 less: variable cost of goods sold 2214000 1640000 574000 gross contribution margin 1890000 1400000 490000 less variable cost of selling & admn 162000 120000 42000 contribution margin 1728000 1280000 448000 traceable fixed expenses 590000 270000 320000 segment margin 1138000 1010000 128000 common fixed expenses 1210000 net income -72000 14) Impact on profit if West is dropped; Total units sold 41600 sales 3161600 less: variable cost of goods sold 1705600 gross contribution margin 1456000 less variable cost of selling & admn 124800 contribution margin 1331200 traceable fixed expenses 270000 segment margin 1061200 common fixed expenses 1210000 net income -148800 The loss will increase by $76,800 15) Total East West units sold 54000 40000 16800 sales 4316800 3040000 1276800 less: variable cost of goods sold 2328800 1640000 688800 gross contribution margin 1988000 1400000 588000 less variable cost of selling & admn 170400 120000 50400 contribution margin 1817600 1280000 537600 traceable fixed expenses 638000 270000 368000 segment margin 1179600 1010000 169600 common fixed expenses 1210000 net income -30400 The loss will decrease by $41600

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