Cornerstone Exercise 17.2 (Algorithmic) Keep-Or-Drop Decision, Alternatives, Relevant Costs

Reshier Company makes three types of rug shampooers. Model 1 is the basic model rented through hardware stores and supermarkets. Model 2 is a more advanced model with both dry-and wet-vacuuming capabilities. Model 3 is the heavy-duty riding shampooer sold to hotels and convention centers. A segmented income statement is shown below.

		Model 1		Model 2		Model 3		Total
Sales		$275,000		$598,000		$623,500		$1,496,500
Less variable costs of goods sold		(86,000)		(175,960)		(358,400)		(620,360)
Less commissions		(4,200)		(36,500)		(20,000)		(60,700)
Contribution margin		$184,800		$385,540		$245,100		$815,440
Less common fixed expenses:
Fixed factory overhead								(380,000)
Fixed selling and administrative								(283,000)
Operating income								$152,440

While all models have positive contribution margins, Reshier Company is concerned because operating income is less than 10 percent of sales and is low for this type of company. The companys controller gathered additional information on fixed costs to see why they were so high. The following information on activities and drivers was gathered:

						Driver Usage by Model
Activity	Activity Cost				Activity Driver	Model 1				Model 2				Model 3
Engineering		$89,000			Engineering hours		750				73				177
Setting up		196,000			Setup hours		12,600				12,800				29,177
Customer service		119,000			Service calls		13,000				1,520				19,177

In addition, Model 1 requires the rental of specialized equipment costing $19,500 per year.

Required:

1. Reformulate the segmented income statement using the additional information on activities. Use a minus sign to indicate any negative margins. Do NOT round interim calculations and, if required, round your answer to the nearest dollar.

Reshier Company
Segmented Income Statement
		Model 1		Model 2		Model 3		Total
Cash Commissions Cost of goods sold Net income Sales Correct 8 of Item 1		$ Correct 9 of Item 1		$ Correct 10 of Item 1		$ Correct 11 of Item 1		$ Correct 12 of Item 1
Less customer services Less engineering Less factory overhead Less variable cost of goods sold Less setting up Correct 13 of Item 1		Correct 14 of Item 1		Correct 15 of Item 1		Correct 16 of Item 1		Correct 17 of Item 1
Less customer services Less engineering Less factory overhead Less commissions Less setting up Correct 18 of Item 1		Correct 19 of Item 1		Correct 20 of Item 1		Correct 21 of Item 1		Correct 22 of Item 1
Contribution margin		$ Correct 24 of Item 1		$ Correct 25 of Item 1		$ Correct 26 of Item 1		$ Correct 27 of Item 1
Less traceable fixed expenses:
Commissions Cost of goods sold Engineering Factory overhead Selling and admin. expense Correct 29 of Item 1		Correct 30 of Item 1		Correct 31 of Item 1		Correct 32 of Item 1		Correct 33 of Item 1
Commissions Cost of goods sold Factory overhead Selling and admin. expense Setting up Correct 34 of Item 1		Correct 35 of Item 1		Correct 36 of Item 1		Correct 37 of Item 1		Correct 38 of Item 1
Commissions Cost of goods sold Equipment rental Factory overhead Selling and admin. expense Correct 39 of Item 1		Correct 40 of Item 1		Correct 41 of Item 1		Correct 42 of Item 1		Correct 43 of Item 1
Commissions Cost of goods sold Customer service Factory overhead Selling and admin. expense Correct 44 of Item 1		Correct 45 of Item 1		Correct 46 of Item 1		Correct 47 of Item 1		Correct 48 of Item 1
Product margin		$ Correct 50 of Item 1		$ Correct 51 of Item 1		$ Correct 52 of Item 1		$ Correct 53 of Item 1
Less common fixed expenses:
Commissions Cost of goods sold Customer services Engineering Factory overhead Correct 55 of Item 1								Correct 56 of Item 1
Commissions Cost of goods sold Customer services Engineering Selling and admin. expense Correct 57 of Item 1								Correct 58 of Item 1
Operating income								$ Correct 60 of Item 1

1. Review what you have learned about segmented income statements in the chapter. To determine the traceable fixed costs, you will need to compute the activity rates for each activity to assign the costs of the activities to each product. Common fixed expenses are not traceable to the segments. They would remain even if one of the segments were eliminated.

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Solution

2. Using your answer to Requirement 1, assume that Reshier Company is considering dropping any model with a negative product margin. What are the alternatives? - Select your answer -Keeping Model 1Dropping Model 1Keeping Model 1 or dropping itCorrect 1 of Item 2

Which alternative is more cost effective and by how much? (Assume that any traceable fixed costs can be avoided.) Do NOT round interim calculations and, if required, round your answer to the nearest dollar. - Select your answer -Keeping Model 1Dropping Model 1Correct 2 of Item 2 will add $ to operating income

3. What if Reshier Company can only avoid 166 hours of engineering time and 4,950 hours of setup time that are attributable to Model 1? How does that affect the alternatives presented in Requirement 2? Which alternative is more cost effective and by how much? Do NOT round interim calculations and, if required, round your answer to the nearest dollar.

- Select your answer -Keeping Model 1Dropping Model 1Correct 4 of Item 2

will add $

to operating income