Diversified Products, Inc., has recently acquired a small publishing company that Diversified Products intends to operate as one of its investment centers. The newly acquired company has three books that it offers for sale—a cookbook, a travel guide, and a handy speller. Each book sells for $10. The publishing company’s most recent monthly income statement is given below:

The following additional information is available about the company:

(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 statement above. Sales commissions are 10% of sales for any product.

(b)        The same equipment is used to produce all three books, so the equipment depreciation cost has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 30% of the time to produce cookbooks, 50% of the time to produce travel guides, and 20% 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 48.000 square feet of space, of which 7,200 square feet is used by the cookbook line, 24,000 square feet by the travel guide line, and 16,800 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.

(f)        All other costs are traceable to the three product lines in the amounts shown on the statement above.

The management of Diversified Products, Inc., is anxious to improve the new investment center’s 5% 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.         After seeing the income statement in the main body of the problem, management has decided to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide.

a.         Based on the statement you have prepared, do you agree with the decision to eliminate the cookbook? Explain.

b.         Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide? Assume that an ample market is available for all three product lines. (Hint: Compute the contribution margin ratio for each product.)

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Product Line Travel Total Handy Speller Company Cook book Guide Sales $300,000 $90,000 $150,000 $60,000 Expenses: 63,000 Printing costs 102,000 27,000 12,000 19,500 3,000 Advertising 36,000 13,500 General sales 18,000 5,400 9,000 3,600 Salaries 33,000 18,000 9,000 6,000 Equipment depreciation 3,000 9,000 3,000 3,000 9,000 Sales commissions 30,000 15,000 6,000 General administration 42,000 14,000 14,000 14,000 6,000 Warehouse rent 12,000 3,600 2,400 Depreciation---office facilities 3,000 1,000 1,000 1,000 Total expenses 139,500 285,000 94,500 51,000 S (4,500) S 10,500 S 15,000 $ 9,000 Net operating income (loss)