Chapter 7, Problem 26P

Answer 1:

To determine

Weaknesses in Company’s Segmented Income Statement

Answer to Problem 26P

Solution:

1. The statement does not reflect the contribution margin.
2. The expenses are appearing in a mixed manner with no segregation as to fixed and variable expenses

Explanation of Solution

1. In order to assess whether the loss is due to higher variable expenses or due to ineffective utilization of fixed resources, computation of contribution margin and net operating margin is required;
2. It is important to understand the nature of expenses like fixed and variable so as to understand their correlation with production and formulated effective measures to control them.

Conclusion

The Segmented Income Statement require redrafting in a manner which reflects contribution

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Answer 2:

To determine

Common Fixed Expenses: are those expenses which cannot be identified to a specific region but normally allocated to different regions on a reasonable basis for the purpose of decision making.

Allocation basis for common fixed advertising (general) expenses and its correctness

Solution (a) :

	West	Central	East	Total
Sales	$ 450,000	$ 800,000	$ 750,000	$2,000,000
% of Total Sales	23%	40%	38%
Advertising − general (Total Advertising exp X % of total sales)	$ 18,000	$ 32,000	$ 30,000	$ 80,000

Explanation of Solution

1. Advertising (general) expenses are given in the question.
2. We are required to determine allocation basis.
3. Since, advertising expenses generally depends on sales, first cross check will be made by computing regional Sales ratio and distributing total advertising (general) expenses in the ratio of this regional sales ratio.

• Given
Sales value and Allocated Advertising Expense are given in the question

• Formula

  $\text{Regional Sales Ratio = }\frac{\text{Region's Sales}}{\text{Total Sales}}$

  $\text{Allocated Advertising (General) Expenses =}\text{Regional Sales Ratio }\times \text{ Total Advertising }\text{}\text{Expenses }$

• Computation

  $\text{Regional Sales Ratio of West = }\frac{\text{\$ 450,000}}{\text{\$ 2,000,000}}=23\%$

  $\text{Regional Sales Ratio of Central = }\frac{\text{\$ 800,000}}{\text{\$ 2,000,000}}=40\%$

  $\text{Regional Sales Ratio of East = }\frac{\text{\$ 750,000}}{\text{\$ 2,000,000}}=38\%$

  $\text{Allocated Advertising (General) Expenses to West = 23\% }\times \text{ \$ 80,000 = \$ 18,000}$

  $\text{Allocated Advertising (General) Expenses to Central = 40\% }\times \text{ \$ 80,000 = \$ 32,000}$

  $\text{Allocated Advertising (General) Expenses to East = 38\% }\times \text{ \$ 80,000 = \$ 30,000}$

Conclusion

As clear from above, Advertising - general expenses have been allocated in ratio of sales. This looks correct as advertising expenses are directly related to sales revenue.

Solution (b)

To determine

Allocation basis for General Administrative Expenses and its correctness

Answer to Problem 26P

Solution: General Administrative Expenses have been distributed equally between all the regions.

Explanation of Solution

• Given
The General Administrative Expenses have been given as $ 50,000 each for all the regions

Conclusion

General Administrative expenses have been distributed equally. This is not correct. General administrative expenses are expenses which are incurred commonly for all the regions. For eg- the rent of corporate office from where all three regions are centrally managed. However, the revenue and margin of all three regions are different. As such, it is advisable to distribute these expenses on some reasonable basis. For eg- rent of common office may be distributed on the basis of floor area each regions' team occupy.

Answer 3:

To determine

Segmented Income Statement in Contribution Format along with percentage to sales

Answer to Problem 26P

Solution:

Millard Corporation Income Statement (contribution format)
Particulars	West	Central	East	Total
Sales	$ 450,000	$ 800,000	$ 750,000	$2,000,000
Cost of Goods Sold	$ 162,900	$ 280,000	$ 376,500	$ 819,400
Cost of Goods Sold as % of Sales	36%	35%	50%	41%
Variable shipping expenses	$ 17,100	$ 32,000	$ 28,500	$ 77,600
Variable shipping expenses as % of Sales	4%	4%	4%	4%
Contribution Margin	$ 270,000	$ 488,000	$ 345,000	$1,103,000
Contribution Margin as % of Sales	60%	61%	46%	55%
Fixed Expenses	$ 238,500	$ 328,000	$ 390,000	$ 956,500
Fixed Expenses as % of Sales	53%	41%	52%	48%
Net Operating Income	$ 31,500	$ 160,000	$ (45,000)	$ 146,500
Net Operating Income as % of sales	7%	20%	-6%	7%

Explanation of Solution

• Given

Sales, Cost of Goods Sold, Variable shipping expenses, Fixed Expenses are given in the question

• Formula

1. $\text{Cost of Goods Sold as \% of Sales = }\frac{\text{Cost of Goods Sold }}{\text{Sales Value}}$
2. $\text{Variable Shipping Expenses as \% of Sales = }\frac{\text{Variable Shipping Expenses}}{\text{Sales Value}}$
3. $\text{Contribution Margin = Sales - Cost of Goods Sold - Variable Shipping Expenses}$
4. $\text{Contribution Margin as \% of Sales = }\frac{\text{Contribution Margin}}{\text{Sales Value}}$
5. $\text{Fixed Expenses as \% of Sales = }\frac{\text{Fixed Expenses}}{\text{Sales Value}}$
6. $\text{Net Operating Income = Contribution Margin - Total Cost}$
7. $\text{Net Operating Income as \% of Sales = }\frac{\text{Net Operating Income}}{\text{Sales Value}}$

Calculation

  $\text{Cost of Goods Sold as \% of Sales for West = }\frac{\text{\$ 162,900 }}{\text{\$ 450,000}}=36\%$

  $\text{Cost of Goods Sold as \% of Sales for Central = }\frac{\text{\$ 280,000 }}{\text{\$ 800,000}}=35\%$

  $\text{Cost of Goods Sold as \% of Sales for East = }\frac{\text{\$ 376,500 }}{\text{\$ 750,000}}=50\%$

  $\text{Cost of Goods Sold as \% of Sales for Total Company = }\frac{\text{\$ 819,400 }}{\text{\$ 2,000,000}}=41\%$

  $\text{Variable Shipping Expenses as \% of Sales for West= }\frac{\text{\$ 17,100}}{\text{\$ 450,000}}=4\%$

$\text{Variable Shipping Expenses as \% of Sales for Centrak= }\frac{\text{\$ 32,000}}{\text{\$ 800,000}}=4\%$

$\text{Variable Shipping Expenses as \% of Sales for East= }\frac{\text{\$ 28,500}}{\text{\$ 750,000}}=4\%$

$\text{Variable Shipping Expenses as \% of Sales for Total Company= }\frac{\text{\$ 77,600}}{\text{\$ 2,000,000}}=4\%$

  $\text{Contribution Margin for West = \$ 450,000 - \$ 162,900 - \$ 17,100 = \$ 270,000}$

$\text{Contribution Margin for West = \$ 800,000 - \$ 280,000 - \$ 32,000 = \$ 488,000}$

$\text{Contribution Margin for West = \$ 750,000 - \$ 376,500 - \$ 28,500 = \$ 345,000}$

$\text{Contribution Margin for West = \$ 2,000,000 - \$ 819,400 - \$ 77,600 = \$ 1,103,000}$

  $\text{Contribution Margin as \% of Sales for West = }\frac{\text{\$ 270,000}}{\text{\$ 450,000}}=60\%$

$\text{Contribution Margin as \% of Sales for West = }\frac{\text{\$ 488,000}}{\text{\$ 800,000}}=61\%$

$\text{Contribution Margin as \% of Sales for West = }\frac{\text{\$ 345,500}}{\text{\$ 750,000}}=46\%$

$\text{Contribution Margin as \% of Sales for Total Company = }\frac{\text{\$ 1,103,000}}{\text{\$ 2,000,000}}=55\%$

Fixed expenses	West	Central	East	Total
Advertising	$ 108,000	$ 200,000	$ 210,000	$ 518,000
Salaries	$ 90,000	$ 88,000	$ 135,000	$ 313,000
Utilities	$ 13,500	$ 12,000	$ 15,000	$ 40,500
Depreciation	$ 27,000	$ 28,000	$ 30,000	$ 85,000
Total fixed expenses	$ 238,500	$ 328,000	$ 390,000	$ 956,500

  $\text{Fixed Expenses as \% of Sales for West= }\frac{\text{\$ 238,500}}{\text{\$ 450,000}}=53\%$

$\text{Fixed Expenses as \% of Sales for West= }\frac{\text{\$ 328,000}}{\text{\$ 800,000}}=41\%$

$\text{Fixed Expenses as \% of Sales for West= }\frac{\text{\$ 390,000}}{\text{\$ 750,000}}=52\%$

$\text{Fixed Expenses as \% of Sales for West= }\frac{\text{\$ 956,500}}{\text{\$ 2,000,000}}=48\%$

  $\text{Net Operating Income for West = \$ 270,000 - \$238,500 = \$ 31,500}$

$\text{Net Operating Income for Central = \$ 488,000 - \$328,000 = \$ 160,000}$

$\text{Net Operating Income for East = \$ 345,000 - \$390,000 = \$ (45,000)}$

$\text{Net Operating Income for Total Company = \$ 1,103,000 - \$956,500 = \$ 146,500}$

  $\text{Net Operating Income as \% of Sales for West = }\frac{\text{\$ 31,500}}{\text{\$ 450,000}}=7\%$

$\text{Net Operating Income as \% of Sales for Central= }\frac{\text{\$ 160,000}}{\text{\$ 800,000}}=20$

$\text{Net Operating Income as \% of Sales for East= }\frac{\text{\$ (45,000)}}{\text{\$ 750,000}}=-6\%$

$\text{Net Operating Income as \% of Sales for Total Company = }\frac{\text{\$ 146,500}}{\text{\$ 2,000,000}}=7\%$

Conclusion

East is the least profitable region and Central is the most profitable region

Answer 4

To determine

Analysis of Segmented Income Statement

Explanation of Solution

1. Central division is not able to meet its direct fixed cost as hence its loss is driving overall profitability downwards. As such, this department needs to be dropped or revamped;
2. West Division is highest contribution yielding division. Also, the fixed resources are also used affectively;
3. East division has good contribution margin. However, fixed cost is also high resulting in overall low net operating margin as compared to West Division. Here, the focus should be made on more effective utilization of fixed resources which will either result in increasing the revenue or reducing the fixed cost.