Keep-Or-Drop Decision, Alternatives, Relevant CostsReshier 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 TotalSales $235,000 $590,000 $658,500 $1,483,500 Less variable costs of goods sold (91,500) (166,280) (356,000) (613,780) Less commissions (5,700) (40,000) (21,750) (67,450)      Contribution margin $137,800 $383,720 $280,750 $802,270 Less common fixed expenses:         Fixed factory overhead       (385,000)  Fixed selling and administrative       (307,000) Operating income       $110,270 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  ActivityActivity Cost Activity DriverModel 1 Model 2Model 3 Engineering$86,000 Engineering hours750 71179         Setting up$196,000 Setup hours12,100 13,20029,179         Customer service$100,000 Service calls13,400 1,48019,179         In addition, Model 1 requires the rental of specialized equipment costing $22,000 per year.Required: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. If amount box does not require an entry, leave it blank or enter "0". Reshier CompanySegmented Income Statement Model 1Model 2Model 3TotalSales $$$$Less variable cost of goods sold     Less commissions     Contribution margin$$$$Less traceable fixed expenses:    Engineering     Setting up     Equipment rental     Customer service     Product margin$$$$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?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 1  will add $_________  to operating income3. What if Reshier Company can only avoid 164 hours of engineering time and 5,250 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

Question
Asked Nov 22, 2019
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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   $235,000   $590,000   $658,500   $1,483,500  
Less variable costs of goods sold   (91,500)   (166,280)   (356,000)   (613,780)  
Less commissions   (5,700)   (40,000)   (21,750)   (67,450)  
     Contribution margin   $137,800   $383,720   $280,750   $802,270  
Less common fixed expenses:                  
Fixed factory overhead               (385,000)  
 Fixed selling and administrative               (307,000)  
Operating income               $110,270  

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 $86,000   Engineering hours 750   71 179                  
Setting up $196,000   Setup hours 12,100   13,200 29,179                  
Customer service $100,000   Service calls 13,400   1,480 19,179                  

In addition, Model 1 requires the rental of specialized equipment costing $22,000 per year.

Required:

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. If amount box does not require an entry, leave it blank or enter "0".

 
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?

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 1  will add $_________  to operating income

3. What if Reshier Company can only avoid 164 hours of engineering time and 5,250 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
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Expert Answer

Step 1

Keep or drop choices assess whether an item, product offering, service, or portion of an organization ought to be dropped or not.

 

Step 2

Working notes:

  • Engineering rate= $86,000 ÷ (730 + 76 + 194) = $86
  • Setting up= $196,000 ÷ (12,100 + 13,200 + 29,179) = $3.5977
  • Customer Service= $100,000 ÷ (13,400 + 1,480 + 19,179) = $2.9360
  • Fixed factory overhead= $385,000 – 86,000 – 195,999 – 22,000 = $81,001
  • Selling and administrative expenses= $307,000 – 99,997 = $207,003
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Reformulated segmented income statement: Model 1 Model 2 Model 3 Total $658,500 $1,483,500 $235,000 $590,000 Sales Less: variable cost of goods sold -613,780 -91,500 -166,280 -356,000 -40,000 Less: commissions -5,700 -21,750 -67,450 Contribution margin $137,800 $280,750 $802,270 S383,720 Less: traceable fixed expenses 64,500 15,394 Engineering 6,106 86,000 Setting up 43,532 47,490 104,977 195,999 Equipment rental 22,000 22,000 39,342 56,310 Customer service 4,345 99,997 Product margin ($31,574) $325,779 $104,069 398,274 Less: fixed common expenses Factory overhead 81,001 Selling and administrative expenses 207,003 Operating income 110,270

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Step 3
  1. The reformulated income statement suggests that the profit of model 1 is negative, so company can choose either model 2 or 3. Since the product margin of m...

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