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		$586,000		$623,500		$1,484,500
Less variable costs of goods sold		(100,000)		(177,720)		(348,000)		(625,720)
Less commissions		(5,800)		(27,000)		(23,250)		(56,050)
Contribution margin		$169,200		$381,280		$252,250		$802,730
Less common fixed expenses:
Fixed factory overhead								(395,000)
Fixed selling and administrative								(307,000)
Operating income								$100,730

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		$80,000			Engineering hours		790				71				139
Setting up		177,000			Setup hours		12,200				12,800				29,139
Customer service		103,000			Service calls		13,600				1,580				19,139

In addition, Model 1 requires the rental of specialized equipment costing $25,000 per year.

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
		$		$		$		$
Contribution margin		$		$		$		$
Less traceable fixed expenses:
Product margin		$		$		$		$
Less common fixed expenses:
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? - 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 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.

- Select your answer -Keeping Model 1Dropping Model 1Correct 4 of Item 2 will add $ to operating income