eep-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		$270,000		$562,000		$645,500		$1,477,500
Less variable costs of goods sold		(95,500)		(175,080)		(332,400)		(602,980)
Less commissions		(5,000)		(29,500)		(24,000)		(58,500)
Contribution margin		$169,500		$357,420		$289,100		$816,020
Less common fixed expenses:
Fixed factory overhead								(410,000)
Fixed selling and administrative								(283,000)
Operating income								$123,020

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		$75,000			Engineering hours		750				73				177
Setting up		194,000			Setup hours		12,900				13,300				29,177
Customer service		111,000			Service calls		14,000				1,440				19,177

In addition, Model 1 requires the rental of specialized equipment costing $22,000 per year.

Required:

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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.

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Partially Correct

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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.

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 178 hours of engineering time and 4,900 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

Reshier Company Segmented Income Statement Model 1 Model 2 Model 3 Total Sales 270000 562000 645500 1477500 Less variable cost of goo -95500 -175080 -332400 602980 Less commissions 5000 -29500 -24000 58500 Contribution margin 169500 357420 289100 816020 Less traceable fixed expenses: Engineering 7500 1027.40 423.73 75000 Setting up 194000 Equipment rental 22000 0 0 22000 Customer service 111000 Product margin Less common fixed expenses Factory overhead 410000 Selling and admin. exper v 410000 Operating income 123020 Reshier Company Segmented Income Statement Model 1 Model 2 Model 3 Total Sales 270000 562000 645500 1477500 Less variable cost of goo -95500 -175080 -332400 602980 Less commissions 5000 -29500 -24000 58500 Contribution margin 169500 357420 289100 816020 Less traceable fixed expenses: Engineering 7500 1027.40 423.73 75000 Setting up 194000 Equipment rental 22000 0 0 22000 Customer service 111000 Product margin Less common fixed expenses Factory overhead 410000 Selling and admin. exper v 410000 Operating income 123020