Gagnon Company reported the following sales and quality costs for the past four years. Assume that all quality costs are variable and that all changes in the quality cost ratios are due to a qual- ity improvement program. Quality Costs as a Percent of Revenues Year Sales Revenues 1 S20,000,000 25% 22,000,000 22,000,000 22 3 18 4 24,000,000 14 Required: 1. Compute the quality costs for all four years. By how much did net income increase from Year 1 to Year 2 because of quality improvements? From Year 2 to Year 3? From Year 3 to Year 4? 2. The management of Gagnon Company believes it is possible to reduce quality costs to 2.5 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional profit potential facing Gagnon. Is the expectation of improving quality and reducing costs to 2.5 percent of sales realistic? Explain. 3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1 and 2, the average bid was $400. In Year 1, total variable costs were $250 per unit. In Year 3, competition forced the bid to drop to $380. Compute the total contribution margin in Year 3 assuming the same quality costs as in Year 1. Now, compute the total contribution margin in Year 3 using the actual quality costs for Year 3. What is the increase in profitabil- ity resulting from the quality improvements made from Year 1 to Year 3?
Gagnon Company reported the following sales and quality costs for the past four years. Assume that all quality costs are variable and that all changes in the quality cost ratios are due to a qual- ity improvement program. Quality Costs as a Percent of Revenues Year Sales Revenues 1 S20,000,000 25% 22,000,000 22,000,000 22 3 18 4 24,000,000 14 Required: 1. Compute the quality costs for all four years. By how much did net income increase from Year 1 to Year 2 because of quality improvements? From Year 2 to Year 3? From Year 3 to Year 4? 2. The management of Gagnon Company believes it is possible to reduce quality costs to 2.5 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional profit potential facing Gagnon. Is the expectation of improving quality and reducing costs to 2.5 percent of sales realistic? Explain. 3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1 and 2, the average bid was $400. In Year 1, total variable costs were $250 per unit. In Year 3, competition forced the bid to drop to $380. Compute the total contribution margin in Year 3 assuming the same quality costs as in Year 1. Now, compute the total contribution margin in Year 3 using the actual quality costs for Year 3. What is the increase in profitabil- ity resulting from the quality improvements made from Year 1 to Year 3?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Gagnon Company reported the following sales and quality costs for the past four years. Assume
that all quality costs are variable and that all changes in the quality cost ratios are due to a qual-
ity improvement program.
Quality Costs as a
Percent of Revenues
Year
Sales Revenues
1
S20,000,000
25%
22,000,000
22,000,000
22
3
18
4
24,000,000
14
Required:
1. Compute the quality costs for all four years. By how much did net income increase from Year
1 to Year 2 because of quality improvements? From Year 2 to Year 3? From Year 3 to Year 4?
2. The management of Gagnon Company believes it is possible to reduce quality costs to
2.5 percent of sales. Assuming sales will continue at the Year 4 level, calculate the additional
profit potential facing Gagnon. Is the expectation of improving quality and reducing costs
to 2.5 percent of sales realistic? Explain.
3. Assume that Gagnon produces one type of product, which is sold on a bid basis. In Years 1
and 2, the average bid was $400. In Year 1, total variable costs were $250 per unit. In Year
3, competition forced the bid to drop to $380. Compute the total contribution margin in
Year 3 assuming the same quality costs as in Year 1. Now, compute the total contribution
margin in Year 3 using the actual quality costs for Year 3. What is the increase in profitabil-
ity resulting from the quality improvements made from Year 1 to Year 3?
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