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? (Keep Model 1 and Drop Model 1)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 23, 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? (Keep Model 1 and Drop Model 1)

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

1.The activity costs can be allocated between different models based on activity usage as follows

Allocation of Costs as per Activity Rates
Model 1 Model 2 Model 3 Total
1000
Engineering hrs (a)
Total cost (b)
Engineering cost per hour (Total
cost/total engineering hrs)
Allocated engineering cost
(engineering hrs cost per hour)
750
71
179
86,000
86
86000
6106
64500
15394
Model 1 Model 2 Model 3 Total
54479
Setup hrs (a)
Total cost (b)
12100
13200
29179
196,000
Setting cost per hour (Total cost/total
setup hrs)
Allocated setting cost (setup hrs cost
per hour)
3.597717
43532.37 47489.86 104977.8|
196000
Model 1 Model 2 Model 3 Total
34059
100,000
13400
Service calls
Total cost (b)
Setting cost per hour (Total cost/total
setup hrs)
Allocated setting cost (setup hrs cost
19179
1480
2.936082
100000
39343.49 4345.401 56311.11
per hour)
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Allocation of Costs as per Activity Rates Model 1 Model 2 Model 3 Total 1000 Engineering hrs (a) Total cost (b) Engineering cost per hour (Total cost/total engineering hrs) Allocated engineering cost (engineering hrs cost per hour) 750 71 179 86,000 86 86000 6106 64500 15394 Model 1 Model 2 Model 3 Total 54479 Setup hrs (a) Total cost (b) 12100 13200 29179 196,000 Setting cost per hour (Total cost/total setup hrs) Allocated setting cost (setup hrs cost per hour) 3.597717 43532.37 47489.86 104977.8| 196000 Model 1 Model 2 Model 3 Total 34059 100,000 13400 Service calls Total cost (b) Setting cost per hour (Total cost/total setup hrs) Allocated setting cost (setup hrs cost 19179 1480 2.936082 100000 39343.49 4345.401 56311.11 per hour)

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Step 2

The common expenses to be deducted from total profits after allocation has been computed as follows

Common factory overhead cost to be deducted
Total factory overhead
less. Engineering
Setting up
Equipment rental
Common factory overhead cost
385000
-86000
-196000
-22000
81000
Common selling and admin cost to be deducted
Total selling & admin
less. Customer service
Common selling and admin cost
307000
-100000
207000
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Common factory overhead cost to be deducted Total factory overhead less. Engineering Setting up Equipment rental Common factory overhead cost 385000 -86000 -196000 -22000 81000 Common selling and admin cost to be deducted Total selling & admin less. Customer service Common selling and admin cost 307000 -100000 207000

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Step 3

The required income statement after allocating ...

1 Reshier Company
Segmented Income statement
Model 1 Model 2 Model 3 Total
235000
-91500166280-356000 -613780
Sales
590000
658500 1483500
Less. Variable cost of goods sold
less.Commissions
-40000
-67450
-5700
-21750
383720
Contribution margin
less.traceable fixed expenses
Engineering
Setting up
Equipment rental
802270
137800
280750
-64500
-43532.447489.9-104978-196000
-22000
-86000
-6106
-15394
-22000
0
0
Customer service
-39343.5
-4345.4-56311.1-100000
Product margin
Less Common fixed expenses
Factory overhead
selling and admin expense
Operating income
-31575.9325778.7 104067.1
398270
-81000
-207000
110270
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1 Reshier Company Segmented Income statement Model 1 Model 2 Model 3 Total 235000 -91500166280-356000 -613780 Sales 590000 658500 1483500 Less. Variable cost of goods sold less.Commissions -40000 -67450 -5700 -21750 383720 Contribution margin less.traceable fixed expenses Engineering Setting up Equipment rental 802270 137800 280750 -64500 -43532.447489.9-104978-196000 -22000 -86000 -6106 -15394 -22000 0 0 Customer service -39343.5 -4345.4-56311.1-100000 Product margin Less Common fixed expenses Factory overhead selling and admin expense Operating income -31575.9325778.7 104067.1 398270 -81000 -207000 110270

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