Building Your Skills COMPREHENSIVE PROBLEM [L01 CC3; L02 CCS, 6, 7] Allen Moving and Storage prepared the following income statement For 2018: CHECK FIGURE {2) Break-even sales = $4,838,485 Revenues: Local $1,433,500 [mm-province 5 10.000 Interprovince 2,490,500 Containers 333,000 Packing 437.000 Storage M Total revenues $5 ,493,000 Less expenses: Outside vehicle repair $ 220,000 Fuel 352,000 Sales commissions 102,000 Tires, oil, lube 20,500 Wages (driver and helper) 1,584,000 CHAPTER 8: COSTVOLUMEPROFIT RELATIONSHIPS 491 Internal maintenance 293,000 Advertising 88,000 Equipment rental 422,000 Packing materials 557,000 Salaries 821 .000 Cargo loss claims 234,000 Utilities 16,700 Insurance 44,000 Fuel taxes and tariffs 132,000 Bad debt 193,000 Depreciation 205 000 Total expenses 5,284.21!!! Operating income 39 208,800 Less: Taxes (42%} 87 696 Net income $ 121,104 Upon reviewing the income statement for 2018, chief nancial officer Suzie Allen called a meeting to discuss the company's financial status. She invited sales manager Heidi Strom and controller Gautam Singh. Allen: Our before-tax income has dropped from a high of 12% of sales to about 4% this last year. I know that both of you are aware of our problem and have some suggestions on how we can improve the situation. Strom: Suzie. competition has become quite intense in our industry. I have two suggestions to help improve sales. First, we need to increase our advertising budget, We have a good reputation, and 1 think we need to capitalize on it. I suggest that we emphasize our expertise in crating electronic equipment and other sensitive instruments. Our losses in this area are minuscule. We have a much better record than any of our competitors, and we need to let customers and potential customers know about the quality of ottr services. Allen: That sounds good. How much more do you need for advertising, and what kind of increase in sales would you predict?" Strom: To do it right. I would need to double our current advertising budget. I would guess that sales would increase by 20%. I also have another suggestion. I think we should look at the international goods and freightmoving market. Many firms ship goods internationally. and I believe that they would switch to us if we entered that market. My preliminary analysis reveals that we could pick up $500,000 of sales during the first year. Allen: Both suggestions seem to offer seine potential for improving ottr profitability. Gautam, would yell gather the data needed to estimate the effect of each of these two alternatives on our profits? Singh: Sure. [ have a suggestion alsoI plan to install a cost accounting system. At this point, we have no real idea how much each of our services is costing. I believe that there is some hope of reducing costs without affecting the quality of our services. Allen: I'm all for reducing costs where possible. However, keep in mind that I don't want to lay off any employees yet, I like the idea of providing security to our employees. 1 would rather see everyone take a pay cut before we redttee our workforce. So far, we have been able to keep everyone despite the drop in our sales. I think it's a good Financia|&ManagerialAccounting... O 492 CHAPTER 8: COSTVOLUMEPROFIT RELATIONSHIPS policy. If these two ideas of Heidi's work out, no new hires may be necessary, and we have trained, loyal employees ready for the new business. Required: 1. Classify all expenses in the 2018 income statement as either variable or xed. Assume that each expense is strictly variable or strictly fixed with respect to sales revenue. Once the classification is completed, prepare a contribution margin income statement. 2. Using the information obtained in Requirement 1, compute the revenue that Allen Moving and Storage needs to generate to break even. Now compute the revenue that is needed to earn operating income equal to 12% of sales revenue. 3. What is the maximum amount that Suzie can spend on additional advertising assuming that profits remain unchanged for 2019 and sales will increase by 20%, as predicted by Heidi? Suppose that Suzie spends the amount Heidi requested and sales increase by 20%: what will be the change in profits? Should Heidi's suggestion be adopted? 4. Suppose that the directly traceable fixed expenses associated with entry into the international market are $200,000. Assume that the variable-cost ratio for this segment is the same as that computed in the 2018 income statement prepared in Requirement 1. How much revenue must be generated from international shipping for this segment to break even? What is the expected margin of safety? Would you recommend entry into the international market? Why? 5. Suppose that Suzie Allen decides both to increase advertising and to enter the international market. Assume that actual sales increase by 10%, with $340,000 of the increase coming from international sales and the remainder from the increased advertising. Using data from Requirements 1 and 4, answer the following questions: a. How much did operating income change because of these two decisions? b. What is the prot change attributable to the advertising campaign? The international market? What is your recommendation for the coming year? Should the company continue these two strategies? Or should it do only one or neither? Explain. c. Suppose that the company achieved its target profit of 12% of sales in spite of the less-than-expected increase in profits from the advertising campaign and the international market. The remaining increase in profits was achieved by cutting variable costs. What is the new variable-cost ratio