Chapter 8, Problem 56P

Segmented Income Statement, Management Decision Making

FunTime Company produces three lines of greeting cards: scented, musical, and regular. Segmented income statements for the past year are as follows:

Kathy Bunker, president of FunTime, is concerned about the financial performance of her firm and is seriously considering dropping both the scented and musical product lines. However, before making a final decision, she consults Jim Dorn, FunTime’s vice president of marketing.

Required:

1. 1. CONCEPTUAL CONNECTION Jim believes that by increasing advertising by $1,000 ($250 for the scented line and $750 for the musical line), sales of those two lines would increase by 30%. If you were Kathy, how would you react to this information?
2. 2. CONCEPTUAL CONNECTION Jim warns Kathy that eliminating the scented and musical lines would lower the sales of the regular line by 20%. Given this information, would it be profitable to eliminate the scented and musical lines?
3. 3. CONCEPTUAL CONNECTION Suppose that eliminating either line reduces sales of the regular cards by 10%. Would a combination of increased advertising (the option described in Requirement 1) and eliminating one of the lines be beneficial? Identify the best combination for the firm.

To determine

Describe the reaction of Person K on the increase in advertisement expense and sales.

Explanation of Solution

Segmented Income Statement:

Variable costing is used in the preparation of a segmented income statement. In this income statement, the variable expenses are recorded separately from the fixed expenses which are further divided into direct fixed expenses and common expenses.

The following table represents the segmented income statement of Company F:

Company F
Segmented Income Statement
For the Previous Year
	Scented ($)	Musical ($)	Regular ($)	Total ($)
Sales1	13,000	19,500	25,000	57,500
Less variable expenses2	9,100	15,600	12,500	37,200
Contribution margin	3,900	3,900	12,500	20,300
Less direct fixed expenses3:	4,250	5,750	3,000	13,000
Segment margin	(350)	(1,850)	9,500	7,300
Less common fixed expenses:				7,500
Operating income (loss)				(200)

Table (1)

The amount of operating loss is $200. Person K should accept the increase in the direct fixed expense and sales. The overall operating loss before the increase is $1,000 whereas the overall operating loss after the increase is $200. This represents that there is a decrease in the operating loss after an increase in the direct fixed expense and sales.

Working Notes:

1. Calculation of revised sales for scented cards:

$\begin{array}{c}\text{Revised sales}=\text{Sales}+\left(\text{Sales}\times \text{Increased percentage}\right)\\ =\$10,000+\left(\$10,000\times 30\%\right)\\ =\$10,000+\$3,000\\ =\$13,000\end{array}$

Hence, the amount of revised sales for scented cards is $13,000.

Calculation of revised sales for musical cards:

$\begin{array}{c}\text{Revised sales}=\text{Sales}+\left(\text{Sales}\times \text{Increased percentage}\right)\\ =\$15,000+\left(\$15,000\times 30\%\right)\\ =\$15,000+\$4,500\\ =\$19,500\end{array}$

Hence, the amount of revised sales for musical cards is $19,500.

2. Calculation of revised variable expense for scented cards:

$\begin{array}{c}\text{Revised variable expense}=\text{Variable expense}+\left(\begin{array}{l}\text{Variable expense}\\ \times \text{Increased percentage}\end{array}\right)\\ =\$7,000+\left(\$7,000\times 30\%\right)\\ =\$7,000+\$2,100\\ =\$9,100\end{array}$

Hence, the amount of revised variable expense for scented cards is $9,100.

Calculation of revised variable expense for musical cards:

$\begin{array}{c}\text{Revised variable expense}=\text{Variable expense}+\left(\begin{array}{l}\text{Variable expense}\\ \times \text{Increased percentage}\end{array}\right)\\ =\$12,000+\left(\$12,000\times 30\%\right)\\ =\$12,000+\$3,600\\ =\$15,600\end{array}$

Hence, the amount of revised variable expense for musical cards is $15,600.

3. Calculation of revised fixed direct expense for scented cards:

$\begin{array}{c}\text{Revised fixed direct expense}=\text{Fixed direct expense}+\text{Additional expense}\\ =\$4,000+\$250\\ =\$4,250\end{array}$

Hence, the revised fixed direct expense for scented cards is $4,250.

Calculation of revised fixed direct expense for musical cards:

$\begin{array}{c}\text{Revised fixed direct expense}=\text{Fixed direct expense}+\text{Additional expense}\\ =\$5,000+\$750\\ =\$5,750\end{array}$

Hence, the revised fixed direct expense for musical cards is $5,750.

To determine

Describe whether it would be beneficial for the company to eliminate the scented and musical lines.

Explanation of Solution

The following table represents the operating income or loss after eliminating scented and musical lines:

Company F
Segmented Income Statement
For the Previous Year
	Regular ($)
Sales1	20,000
Less variable expenses2	10,000
Contribution margin	10,000
Less direct fixed expenses:	3,000
Segment margin	7,000
Less common fixed expenses:	7,500
Operating income (loss)	(500)

Table (2)

The amount of operating loss is $500. If the company eliminates the scented and musical lines, then the sales and variable expenses will get reduced by 20%. The overall operating loss was $1,000 but the revised operating loss after eliminating scented and musical line is $500.

Although the operating loss decreases, still it is not profitable because when the direct fixed expenses of scented and musical lines increase, the operating loss reduces to $200.

Working Notes:

1. Calculation of revised sales:

$\begin{array}{c}\text{Revised sales}=\text{Sales}-\left(\text{Sales}\times \text{Decreased percentage}\right)\\ =\$25,000-\left(\$25,000\times 20\%\right)\\ =\$25,000-\$5,000\\ =\$20,000\end{array}$

Hence, the amount of revised sales is $20,000.

2. Calculation of revised variable expense:

$\begin{array}{c}\text{Revised variable expense}=\text{Variable expense}-\left(\begin{array}{l}\text{Variable expense}\\ \times \text{Decreased percentage}\end{array}\right)\\ =\$12,500-\left(\$12,500\times 20\%\right)\\ =\$12,500-\$2,500\\ =\$10,000\end{array}$

Hence, the amount of revised variable expense is $10,000.

To determine

Describe whether the combination of an increase in advertising and eliminating either of the lines would be beneficial. Also, identify the best combination.

Explanation of Solution

Since the musical line has the highest segment loss, the line should be eliminated. The following table represents the income statement after eliminating musical lines:

Company F
Segmented Income Statement
For the Previous Year
	Scented ($)	Regular ($)	Total ($)
Sales1	13,000	22,500	35,500
Less variable expenses2	9,100	11,250	20,350
Contribution margin	3,900	11,250	15,150
Less direct fixed expenses3:	4,250	3,000	7,250
Segment margin	(350)	8,250	7,900
Less common fixed expenses:			7,500
Operating income (loss)			400

Table (3)

Therefore, the amount of operating income is $400. The company should consider this type of combination as it is more profitable than any other combination.

Working Notes:

1. Calculation of revised sales for scented cards:

$\begin{array}{c}\text{Revised sales}=\text{Sales}+\left(\text{Sales}\times \text{Increased percentage}\right)\\ =\$10,000+\left(\$10,000\times 30\%\right)\\ =\$10,000+\$3,000\\ =\$13,000\end{array}$

Hence, the amount of revised sales for scented cards is $13,000.

Calculation of revised sales for the regular line:

$\begin{array}{c}\text{Revised sales}=\text{Sales}-\left(\text{Sales}\times \text{Decreased percentage}\right)\\ =\$25,000-\left(\$25,000\times 10\%\right)\\ =\$25,000-\$2,500\\ =\$22,500\end{array}$

Hence, the amount of revised sales for the regular line is $22,500.

2. Calculation of revised variable expense for scented cards:

$\begin{array}{c}\text{Revised variable expense}=\text{Variable expense}+\left(\begin{array}{l}\text{Variable expense}\\ \times \text{Increased percentage}\end{array}\right)\\ =\$7,000+\left(\$7,000\times 30\%\right)\\ =\$7,000+\$2,100\\ =\$9,100\end{array}$

Hence, the amount of revised variable expense for scented cards is $9,100.

Calculation of revised variable expense for the regular line:

$\begin{array}{c}\text{Revised variable expense}=\text{Variable expense}-\left(\begin{array}{l}\text{Variable expense}\\ \times \text{Decreased percentage}\end{array}\right)\\ =\$12,500-\left(\$12,500\times 10\%\right)\\ =\$12,500-\$1,250\\ =\$11,250\end{array}$

Hence, the amount of revised variable expense for the regular line is $11,250.

3. Calculation of revised fixed direct expense for scented cards:

$\begin{array}{c}\text{Revised fixed direct expense}=\text{Fixed direct expense}+\text{Additional expense}\\ =\$4,000+\$250\\ =\$4,250\end{array}$

Hence, the revised fixed direct expense for scented cards is $4,250.