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		$225,000		$562,000		$603,000		$1,390,000
Less variable costs of goods sold		(88,000)		(161,440)		(340,000)		(589,440)
Less commissions		(5,800)		(29,500)		(18,000)		(53,300)
Contribution margin		$131,200		$371,060		$245,000		$747,260
Less common fixed expenses:
Fixed factory overhead								(395,000)
Fixed selling and administrative								(295,000)
Operating income								$57,260

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 company's 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		740				72				188
Setting up		186,000			Setup hours		12,700				13,500				29,188
Customer service		101,000			Service calls		14,000				1,420				19,188

In addition, Model 1 requires the rental of specialized equipment costing $23,000 per year.

Reshier Company Segmented Income Statement

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

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?

Keeping Model 1 or dropping it

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 will add $____________ to operating income

3. What if Reshier Company can only avoid 182 hours of engineering time and 5,200 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