Question

Diversified Products, Inc., has recently acquired a small publishing company that offers three books for sale—a cookbook, a travel guide, and a handy speller. Each book sells for $10. The publishing company’s most recent monthly income statement is given below:

				Product Line
	Total Company			Cookbook			Travel Guide			Handy Speller
Sales	$	300,000		$	90,000		$	150,000		$	60,000
Expenses:
Printing costs		102,000			27,000			63,000			12,000
Advertising		36,000			13,500			19,500			3,000
General sales		18,000			5,400			9,000			3,600
Salaries		33,000			18,000			9,000			6,000
Equipment depreciation		9,000			3,000			3,000			3,000
Sales commissions		30,000			9,000			15,000			6,000
General administration		42,000			14,000			14,000			14,000
Warehouse rent		12,000			3,600			6,000			2,400
Depreciation—office facilities		3,000			1,000			1,000			1,000
Total expenses		285,000			94,500			139,500			51,000
Net operating income (loss)	$	15,000		$	(4,500)		$	10,500		$	9,000

The following additional information is available about the company:

a.	Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the statement above. Sales commissions are 10% of sales for any product.
b.	The same equipment is used to produce all three books, so the equipment depreciation cost has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 30% of the time to produce cookbooks, 50% of the time to produce travel guides, and 20% of the time to produce handy spellers.
c.	The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is $3 per square foot per year. The warehouse contains 48,000 square feet of space, of which 7,200 square feet is used by the cookbook line, 24,000 square feet by the travel guide line, and 16,800 square feet by the handy speller line.
d.	The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars.
e.	The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines.
f.	All other costs are traceable to the three product lines in the amounts shown on the statement above.

     The management of Diversified Products, Inc., is anxious to improve the publishing company's 5% return on sales.

Required:

1.	Prepare a new contribution format segmented income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional information provided.

          

2.	After seeing the income statement in the main body of the problem, management has decided to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide.

a.

Based on the statement you have prepared, do you agree with the decision to eliminate the cookbook?

	Yes
	No

b-1.	Compute the contribution margin ratio for each product. (Round your answers to the nearest whole percent.)

                 

Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide?

	Yes
	No

Answer 1

Answer to Part b-1

Contribution Margin Ratio = Contribution Margin / Sales * 100

Cookbook:
Contribution Margin Ratio = 54,000 / 90,000 * 100
Contribution Margin Ratio = 60%

Travel Guide:
Contribution Margin Ratio = 72,000 / 150,000 * 100
Contribution Margin Ratio = 48%

Handy Speller:
Contribution Margin Ratio = 42,000 / 60,000 * 100
Contribution Margin Ratio = 70%

No, the Decision to focus all available resources on promoting the Travel guide is inappropriate, as it has lowest Contribution Margin.