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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		$250,000		$566,000		$620,500		$1,436,500
Less variable costs of goods sold		(95,000)		(160,560)		(363,200)		(618,760)
Less commissions		(5,000)		(25,500)		(22,500)		(53,000)
Contribution margin		$150,000		$379,940		$234,800		$764,740
Less common fixed expenses:
Fixed factory overhead								(395,000)
Fixed selling and administrative								(295,000)
Operating income								$74,740

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		$77,000			Engineering hours		790				70				140
Setting up		180,000			Setup hours		12,300				12,600				29,140
Customer service		106,000			Service calls		14,500				1,580				19,140

In addition, Model 1 requires the rental of specialized equipment costing $20,000 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. If amount box does not require an entry, leave it blank or enter "0".

Reshier Company
Segmented Income Statement
	Model 1	Model 2	Model 3	Total
Sales	$	$	$	$
Less variable cost of goods sold
Less commissions
Contribution margin	$	$	$	$
Less traceable fixed expenses:
Engineering
Setting up
Equipment rental
Customer service
Product margin	$	$	$	$
Less common fixed expenses:
Factory overhead
Selling and admin. expense
Operating income				$

Feedback

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? Dropping Model 1

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. Dropping Model 1 will add $ to operating income

3. What if Reshier Company can only avoid 188 hours of engineering time and 5,350 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.

Keeping Model 1 will add $ to operating income