Diego Company manufactures one product that is sold for $80 per unit in two geog

Question

Diego Company manufactures one product that is sold for $80 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 40,000 units and sold 35,000 units.

Variable costs per unit:
Manufacturing:
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14
Variable manufacturing overhead . . . . . . . . . . . . . . . $2
Variable selling and administrative . . . . . . . . . . . . . . . . $4
Fixed costs per year:
Fixed manufacturing overhead . . . . . . . . . . . . . . . . . . . $800,000
Fixed selling and administrative expenses . . . . . . . . . . $496,000
The company sold 25,000 units in the East region and 10,000 units in the West region. It determined
that $250,000 of its fixed selling and administrative expenses is traceable to the West region,
$150,000 is traceable to the East region, and the remaining $96,000 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.
Required:
Answer each question independently based on the original data unless instructed otherwise. You do
not need to prepare a segmented income statement until question 13.
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 under variable costing?
5. What is the company’s total gross margin under absorption costing?
6. What is the company’s net operating income under absorption costing?
7. What is the amount of the difference between the variable costing and absorption costing net
operating incomes? What is the cause of this difference?
8. What is the company’s break-even point in unit sales? Is it above or below the actual sales
volume? Compare the break-even sales volume to your answer for question 6 and comment.
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 if it had produced
and sold 35,000 units? You do not need to perform any calculations to answer this question.
11. What would have been the company’s absorption costing net operating income if it had
produced and sold 35,000 units? You do not need to perform any calculations to answer this
question.
12. If the company produces 5,000 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? Why? No calculations are necessary.
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 $50,000 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 $30,000 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?

Explanation / Answer

Answer:1

Unit product cost under variable costing : Direct material (24)+ direct labor(14) + variable manufacturing overhead (2) = $40

Answer:2

Unit product cost under variable costing : Direct material (24)+ direct labor(14) + variable manufacturing overhead (2) + Fixed manufacturing overhead (800000/40000) = $60

Answer:3

Sales = 35000*$80 = $2800000

COGS= 35000*$40 =$1400000

Contribution margin = Sales- COGS

= 2800000-1400000 = $1400000

Answer:4

Selling and administrative expenses = 35000*$4=140000

Net operating income under variable costing = Contribution margin - selling and administrative expenses

= 1400000-140000 =$1260000

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