Diego Company manufactures one product that is sold for $80 per unit in two geographic regions the East and West regions. The following information pertains to the company’s first year of operations in which it produced 40,000 units and sold 35,000 units.

 

(Please see homework template)

 

The company sold 25,000 units in the East region and 10,000 units in the West region. It determined that $250,000 of its fixed selling and administrative expenses is traceable to the West region, $150,000 is traceable to East region, and the remaining $96,000 is a common fixed cost. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.

 

 

 

Required:

 

Answer each question independently based on the original data unless instructed otherwise. You do not need to prepare a segmented income statement until question 13.

 

1.        What is the unit product cost under variable costing?

 

2.        What is the unit product cost under absorption costing?

 

3.        What is the company’s total contribution margin under variable costing?

 

4.        What is the company’s net operating income under variable costing?

 

5.        What is the company’s total gross margin under absorption costing?

 

6.        What is the company’s net operating income under absorption costing?

 

7.        What is the amount of the difference between the variable costing and absorption costing net operating incomes? What is the cause of this difference?

 

8.        What is the company’s break-even point in unit sales? Is it above or below the actual sales volume? Compare the break-even sales volume to your answer for question 6 and comment.

 

9.        If the sales volume in the East and West regions had been reversed, what would be the company’s overall break-even point in unit sales?

 

10.     What would have been the company’s variable costing net operating income if it had produced and sold 35,000 units? You do not need to perform any calculations to answer this question.

 

11.     What would have been the company’s absorption costing net? Operating income if it had produced and sold 35,000 units? You do not need to perform any calculations for this question.

 

12.     If the company produces 5,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year2? Why? No calculations are necessary.

 

13.     Prepare a contribution format segment segmented income statement that includes a total column and columns for East and West regions.

 

14.     Diego is considering eliminating the West region because an internally generated report suggests the region’s total gross margin in the first year of operations was $50,000 less than its traceable fixed selling and administrative expenses. Diego believes that if it drops the West region’s sales, the East region’s sales will grow by 5% in year2. Using the contribution approach for analyzing segment profitability and assuming all else remains constant in year2, what would be the profit impact of dropping the West region in Year2?

 

15.     Assume the West region invests $30, 000 in a new advertising campaign in Year2 that increases its unit sales by 20%. If all else remains constant, what would be the profit impact of pursuing the advertising campaign?

 

 

 

2. ETHICS CHALLENGE:

 

Aristotle Constantinos, the manager of Dura Products’ Australian Division, is trying to set the production schedule for the last quarter of the year. The Australian Division had planned to sell 100,000 units during the year, but current projections indicate sales will be only 78,000 units in total. By September 30 the following activity had been reported:

 

Inventory, January 1…………………… 0

 

Production……………………………72,000

 

Sales…………………………………….60,000

 

Inventory, September30……..12,000

 

 

 

Demand has been soft, and the sales forecast for the last quarter is only 18,000 units.

 

The division can rent warehouse space to store up to 30,000 units. The division should maintain a minimum inventory level of at least 1,500 units. Mr. Constantinos is aware that production must be at least 6,000 units per quarter in order to retain a nucleus of key employees. Maximum production capacity is 45,000 units per quarter. Due to the nature of the division’s fixed manufacturing overhead is a major element of product cost.

 

Required:

 

1.        Assume that the division is using variable costing. How many units should be scheduled for production during the last quarter of the year? (The basic formula for computing the required production for a period in a company is: Expected sales + Desired ending inventory – Beginning inventory = Required production.) Show computations and explain your answer. Will the number of unit’s schedules for production affect the division’s reported profit for the year? Explain.

 

2.        Assume that the division is using absorption costing and that the divisional manager is given an annual bonus based on the division’s net operating income. If Mr. Constantinos wants to maximize his division’s net operating income for the year, how many units should be scheduled for production during the last quarter? (See the formula in (1) above.) Explain.

3.        Identify the ethical issues involved in the decision Mr. Constantinos must make about the level of production for the last quarter of the year.