PR 20-5A Segment variable costing income statement and effect on income of change in operations

Valdespin Company manufactures three sizes of camping tents-small (S), medium (M), and large (L). The income statement has consistently indicated a net loss for the M size, and management is considering three proposals: (1) continue size M. (2) discontinue Size M and reduce total output accordingly, or (3) discontinue size M and conduct an advertising campaign to expand the sales of Size S so that the entire plant capacity can continue to be used.

If Proposal 2 is selected and Size M is discontinued and production curtailed, the annual fixed production costs and fixed operating expenses could be reduced by 46,080 and $32, 240 respectively. If Proposal 3 is selected, it is anticipated that an additional annual expenditure of $34, 560 for the rental of additional warehouse space vwould yield an additional 130% in Size S sales volume. It is also assumed that the increased production of Size S would utilize the plant facilities released by the discontinuance of Size M.

The sales and costs have been relatively stable over the past few years, and they are expected to remain so for the foreseeable future. The income statement for the past year ended June 30, 2016, is as follows:

Size

S M L Total

Sales. $668,000 $737,300 $956,160 $2,361,460

Cost of goods:

Variable costs $300,000 $357,120 $437,760 $1,094,880

Fixed costs 74,880 138,250 172,800 385,930

Total cost of goods sold. $374,880 $495,370 $610,560 $1,480,810

Gross profit. $293,120 $241,930 $345,600 $880,650

Less operating expenses:

Variable expenses. $132,480 $155,500 $195,840 $483,820

Fixed expenses.. 92,160 103,680 115,200 311,040

Total operating expenses. $224,640 $259,180 $311,040 $794,860

Instructions

Prepare an income statement for the past year in the variable costing format. Use the following headings:

Size

S M L Total

Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin, as reported in the Total column, to determine income from operations.

Based on the income statement prepared in (1) and the other data presented, determine the amount by which total annual income from operations would be reduced below its present level if Proposal 2 is accepted.

Prepare an income statement in the variable costing format, indicating the projected annual income from operations if Proposal 3 is accepted. Use the following Headings:

Size

S L Total

Data each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin as reported in the Total column. For purposes of the problem, the expenditure of $34,560 for the rental of additional warehouse space can be added to the fixed operating expenses.

By how much would the total annual income increase above its present level if Proposal 3 is accepted? Explain