PART A: Extreme Sports sells logo sports merchandise. The company is contemplating whether or not to continue its custom embroidery service. All of the company's direct fixed costs can be avoided if a segment is dropped. This information is available for the segments below: Custom Embroidery Service Logo Apparel Sales $ 60,000 $ 250,000 Variable Costs 30,000 110,000 Contribution Margin 30,000 140,000 Direct Fixed Costs 22,000 40,000 Allocated Common Fixed Costs 12,000 50,000 Net Income $ (4,000) $ 50,000 Required: (make sure to show your work) 1. What will be the impact on net income if the embroidery segment is dropped?

2. Assume that if the embroidery segment is dropped, apparel sales will increase 10%. What is the impact on the contribution margin and net income solely for the apparel?

3. Identify one cost that is not relevant in this analysis and explain why it is not relevant.

PATRT B: Based on the below CASE of LANDAU Company, you are required to answer ALL of the following QUESTIONS: 1. Discuss the main issues faced by Landau Company?

2. Explain the reasons (and show your work) for the $29,287 difference in July between the incomes before taxes under the two different methods.

3. Critique the various pros and cons of the variable costing proposal that were presented in the meeting. Landau Company In early August, Terry Silver, the new marketing vice president of Landau Company, was studying the July income statement. Silver found the statement puzzling: July's sales had increased significantly over June's, yet income was lower in July than in June. Silver was certain that margins on Landau's products had not narrowed in July and therefore felt that there must be some mistake in the July statement. When Silver asked the company's chief accountant, Meredith Wilcox, for an explanation, Wilcox stated that "production in July was well below standard volume because of employee vacations. This had caused overhead to be under-absorbed, and a large unfavorable volume variance had been generated, which more than offset the added gross margin from the sales increase. It was company policy to charge all variances to the monthly income statement, and these production volume variances would all wash out by year's end", Wilcox had said. Silver, who knew little about accounting, found this explanation to be "incomprehensible." "With all the people in your department, I don't understand why you can't produce an income statement that reflects the economics or our business. In the company that I left to come here, if sales went up, profits went up. I don't see why that shouldn't be the case here, too"

As Wilcox left Silver's office, a presentation at a recent Institute of Management Accountants meeting came to mind. At that meeting the controller of Winjum Company had described that firm's variable costing system, which charged fixed overhead to income as a period expense and treated only variable production costs as inventoriable product costs. Winjum's controller had stressed that, other things being equal, variable costing caused income to move with sales only, rather than being affected by both sales and production volume as was the case with full absorption costing systems. Wilcox decided to recast the June and July income statements and balance sheets using variable costing. (The income statement as recast and as originally prepared is shown in Exhibit

1.) Wilcox then showed these statements to Terry Silver, who responded, "Now that's more like it! I knew July was a better month for us than June, and your new "variable costing" statements reflect that. Tell your boss [Landau's controller] that at the next meeting of the executive committee I'm going to suggest we change to this new method". At the next executive committee meeting, Silver proposed adoption of variable costing for Landau's monthly internal income statements. The controller also supported this change, saying that it would eliminate the time-consuming efforts of allocating fixed overhead to individual products. These allocations had only led to arguments between product managers and the accounting staff. The controller added that since variable costing segregated the cost of materials, direct labor, and variable overhead from fixed overhead costs, management's cost control efforts would be enhanced. Silver also felt that the margin figures provided by the new approach would be more useful than the present ones for comparing the profitability of individual products. To illustrate the point, he had worked out an example. With full costing, two products in Landau's line, numbers 129 and 243, would appear as follows: Standard Product Production Cost Selling Price Unit Margin Margin Percent 129 $2.54 $4.34 $1.80 41.5 243 3.05 5.89 2.84 48.2 Thus, product 243 would appear to be the more desirable one to sell. But on the proposed basis, the numbers were as follows: Standard Product Production Cost Selling Price Unit Margin Margin Percent 129 $1.38 $4.34 $2.96 68.2 243 2.37 5.89 3.52 59.8

According to Silver, these numbers made it clear that product 129 was the more profitable. At this point, the treasurer spoke up. "If we use this new approach, the next thing we want to know would be what marketing will be required to continue selling at your usual mark-up over variable costs. How are we going to pay the fixed costs then? Besides, in my 38 years of experience, it's the lack of control over long-run costs that can bankrupt a company. I'm opposed to any proposal that causes us to take a myopic view of costs". The president also had some concerns, having further considered the proposal. "In the first place, if I add together the June and July pre-tax profit under each of these methods, I get almost $117,000 with the present method, but only $99,000 under the proposed method. While I'd be happy to lower our reported profits from the standpoints of relations with our employee union and income taxes, I don't think it's a good idea as far as our owners and bankers are concerned. And I share Jamie's [the treasurer's] concern about controlling long-run costs. I think we should defer a decision on this matter until we fully understand all of the implications. =============================================================================== Exhibit 1. LANDAU COMPANY Income Statements Items for June and July June July Absorption Variable Absorption Variable Costing Costing Costing Costing Sales Revenue $865,428 $865,428 $931,710 $931,710 Cost of sales 483,149 337,756 521,758 363,367 Gross margin $382,279 $527,672 $346,163 $568,333 Fixed production overhead 192,883 192,883 Selling and administrative 301,250 301,250 310,351 310,351 Income before taxes $81,029 $33,539 $35,812 $65,099