Question

Severo S.A. of Sao Paulo, Brazil, is organized into two divisions. The company’s contribution format segmented income statement (in terms of the Brazilian currency, the real, R) for last month is given below:

	Divisions
	Total Company			Cloth			Leather
Sales	R	3,675,000		R	2,100,000		R	1,575,000
Variable expenses		1,745,500			980,000			765,500
Contribution margin		1,929,500			1,120,000			809,500
Traceable fixed expenses:
Advertising		634,000			320,000			314,000
Selling and administrative		449,000			230,000			219,000
Depreciation		233,000			117,000			116,000
Total traceable fixed expenses		1,316,000			667,000			649,000
Divisional segment margin		613,500		R	453,000		R	160,500
Common fixed expenses		392,000
Operating income	R	221,500

  
   Top management can’t understand why the Leather Division has such a low segment margin when its sales are only 25% less than sales in the Cloth Division. As one step in isolating the problem, management has directed that the Leather Division be further segmented into product lines. The following information is available on the product lines in the Leather Division:

	Leather Division Product Lines
	Garments			Shoes			Handbags
Sales	R	540,000		R	760,000		R	275,000
Traceable fixed expenses:
Advertising	R	82,000		R	114,000		R	118,000
Selling and administrative	R	32,000		R	37,000		R	42,000
Depreciation	R	21,000		R	58,000		R	37,000
Variable expenses as a percentage of sales		60	%		40	%		50	%

Analysis shows that R108,000 of the Leather Division’s selling and administrative expenses are common to the product lines.

	Handbag Markets
	Domestic			Foreign
Sales	R	220,000		R	55,000
Traceable fixed expenses:
Advertising	R	42,000		R	76,000
Variable expenses as a percentage of sales		42	%		82	%

All of the handbag product line’s selling and administrative expenses and depreciation are common to the markets in which the product is sold. Prepare a contribution format segmented income statement for the handbag product line with segments defined as markets.

3. Refer to the statement prepared in (1) above. The sales manager wants to run a special promotional campaign on one of the product lines over the next month. A marketing study indicates that such a campaign would increase sales of the Garments product line by R202,000 or sales of the shoes product line by R147,000. The campaign would cost R32,000.

a. Compute the increased operating income for these product lines for the expected increased sales.

b. Based on the above results, which product line should be chosen?

• Garments

• Shoes

Answer 1

Required answers are given below: