Gary Gs is a small company that currently operates in Knoxville, TN and has a single product stadium seat cushions bearing the University of Tennessee logo. Eventually Gary wants to expand and sell this product for other university and professional sports teams, and to add other merchandise. In the meantime, Gary is having a little difficulty understanding margins, and operating income and product mix.

Ill never understand this accounting stuff, Gary yelled, waving the income statement he had just received from his accountant in the morning mail. last month we sold 1,000 stadium seat cushions and earned $6,850 in operating income. This month, when we sold 1,500, I thought wed make $10,275. But this income statement shows an operating income of $12,100! How can I ever make plans if I cant predict my income? Im going to give Cathy one last chance to explain this to me, he declared as he picked up the phone to call Cathy, his accountant.

Will you try to explain this operating income thing to me one more time please? Gary asked Cathy. After I saw last months income statement, I though each cushion we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each cushion, and we didnt change our selling price, so I dont understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line.

Taking a deep breath, Cathy replied, Sure, Gary. Id be happy to explain how you made so much more operating income than you were expecting.

Required 1. Assume the role ofCathy. Explain to Gary why his use of operatingincomeper cushion was in eiror 2. Using the following income statements, prepare a contributionmargin income statement for October September October $37,500 Sales Cost of Goods Sold Gross Profit Rent Expense Wages Expense Shipping expense Utilities expense Advertising expense nsurance expense 15,000 1500 3.500 1,250 750 750 400 22,500 1.500 5.000 1.875 750 875 400 eratingincome Wages and advertising are mixed costs. The fixedportion ofeachofthose costs is $500 Whatis Gary's break-evensales in units and dollars? Gary plans to sell 500 seat cushions next month Howmuch operating income can Gary expectto eamnext monthifhe actually realizes his target sales? Gary wasn't happy with the projected income statementyou showedhim for a saleslevel of500 cushions. He wants to knowhowmanyseatc $3,700 in operatingincome. Garyis evaluatingtwo options to increase the number ofcushions sold next month. First, he believes he canincrease sales by advertising in the university newspaper. Gary cain purchase a package of12 adsover the nextmonth for a total ofS1,200. He believes the ads will increase the number ofstadiumseat cushions sold from 500 to 960. Asecond option would be to reduce the selling price. Gary believes a 10% decrease in the pnce wil result in 1,000 cushions sold. Whichplan should Gary implement? At whatlevelof sales would he be indifferent between thetwo plans? Just after Gary completed an income projectionfor 1,200 stadiumseat cushions, his supplier called to inform him of a 20% increase in the cost ofthe cushions that Gary ! purchases, effectively immediately. Gary knows that he carmotpass the entire increase on to his customers but thinks he canp ass on half ofit while only experiencing a 5% decrease in units sold. Should Gary respondto the increase in cost ofgoods soldwith an 3. 4. 5. ushions he will needto sell to eam 6. 7. ncrease inpice 8. Referback to the original information Gary has decided to add stadiumblankets to his product line. He has found a supplier who will provide the blankets for $32, and he plans to sell them for$55. All other variable costs currently incurred for selling the stadium seat cushions will also be incurred for selling blankets. Additional fixed costs ofS350 per month will be incurredif the blankets are takenon as a product line. Gary believes he can sell one blanket for every three stadiumseat cushions. Howmarry cushions will Gary need to sell eachmonth in orderto break even? blankets and seat