Shown below is a segmented income statement for Hickory Company’s three wooden flooring product lines:

$$\begin{array}{lcccc} &\text{Strip}&\text{Plank}&\text{Parquet}&\text{Total}\\\hline \text{Sales revenue}& \$400,000 &\$200,000 &\$300,000 &\$900,000\\ \text{Less: Variable expenses}& 225,000 &120,000 &250,000& 595,000\\ \text{Contribution margin}& \$175,000 &\$ 80,000 &\$ 50,000 &\$305,000\\ \text{Less direct fixed expenses:}\\ \quad\text{Machine rent}& (5,000)& (20,000)& (50,000)& (75,000)\\ \quad\text{Supervision}& (15,000) &(10,000) &(20,000) &(45,000)\\ \quad\text{Depreciation}& (35,000)& (10,000)& (25,000)& (70,000)\\ \text{Segment margin}& \$120,000 &\$ 40,000 &\$(45,000) &\$115,000\\ \end{array}$$

Hickory’s management is deciding whether to keep or drop the parquet product line. Hickory’s parquet flooring product line has a contribution margin of $50,000 (sales of$300,000 less total variable costs of $250,000). All variable costs are relevant. Relevant fixed costs associated with this line include 80% of parquet’s machine rent and all of parquet’s supervision salaries.

1. List the alternatives being considered with respect to the parquet flooring line.

2. List the relevant benefits and costs for each alternative.

3. Which alternative is more cost effective and by how much?

Fresh Foods, a large restaurant chain, needs to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following:

$$\begin{array}{lcc} & \text { Total Cost } & \text { Unit Cost } \\ \hline \text { Direct materials } & \$ 25,000 & \$ 5.00 \\ \text { Direct labor } & 15,000 & 3.00 \\ \text { Variable manufacturing overhead } & 7,500 & 1.50 \\ \text { Variable marketing overhead } & 10,000 & 2.00 \\ \text { Fixed plant overhead } & \underline{30,000} & 6.00 \\ \quad \text { Total } & \underline{\$ 87,500} & \$ \$ 17.50 \\ \hline \end{array}$$

Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

1. What are the alternatives for Fresh Foods?

2. List the relevant cost(s) of internal production and of external purchase.

3. Which alternative is more cost effective and by how much?

4. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much?

List and explain three key features of the segmented income statement.

Gorman Nurseries Inc. grows poinsettias and fruit trees in a green house/nursery operation. The following information was provided for the coming year.

$$\begin{array}{lrr} & \text { Poinsettias } & \text { Fruit Trees } \\ \hline \text { Sales } & \$ 970,000 & \$ 3,100,000 \\ \text { Variable cost of goods sold } & 460,000 & 1,630,000 \\ \text { Direct fixed overhead } & 160,000 & 200,000 \end{array}$$

A sales commission of 4% of sales is paid for each of the two product lines. Direct fixed selling and administrative expense was estimated to be $146,000 for the poinsettia line and$87,000 for the fruit tree line.

Common fixed overhead for the nursery operation was estimated to be $800,000; common selling and administrative expense was estimated to be$450,000.

Prepare a segmented income statement for Gorman Nurseries for the coming year, using variable costing.

Autism is a neurological disorder thought to be caused by mutant alleles of one or more genes in an individual. Scientists had been wondering why the number of children diagnosed as autistic has increased dramatically in the last decade, from 1 in 500 in 2002, to 1 in 88 in 2012. Researchers now think that they might have found at least part of the answer: Men are fathering children at later and later ages. A paper published in the journal Nature in 2012 showed a correlation between paternal age and the incidence of autism; the age of the mother was not a factors How does this observation provide a possible explanation for the apparent increase in the rate of autism?

In the keep-or-drop decision, the company will find which of the following income statement formats most useful?

a. A segmented income statement in the contribution margin format
b. A segmented income statement in the full costing format that is used for financial reporting
c. An overall income statement in the contribution margin format
d. An overall income statement in the full costing format that is used for financial reporting
e. Income statements are of no use in making this type of decision.

How might the decision to drop a product line affect a company's remaining products?

Coed Scents, a national producer of young adult perfumes and colognes, needs to determine if it would be cheaper to produce 100,000 bottles of its most popular perfume, Two AM, for sale in its college town shops or to purchase them from an outside supplier for $25 each. Cost information on internal production includes the following:

$$\begin{array}{lrr} & \text { Total Cost } & \text { Unit Cost } \\ \hline \text { Direct materials } & \$ 2,000,000 & \$ 20.00 \\ \text { Direct labor } & 350,000 & 3.50 \\ \text { Variable manufacturing overhead } & 150,000 & 1.50 \\ \text { Variable marketing overhead } & 250,000 & 2.50 \\ \text { Fixed plant overhead } & 300,000 & 3.00 \\ \text { Total } & \underline{\$ 3,050,000} & \underline{\underline{\$ 30.50}} \end{array}$$

Fixed overhead will continue whether Two AM is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

1. What are the alternatives for Coed Scents?

2. List the relevant cost(s) of internal production and of external purchase.

3. Which alternative is more cost effective and by how much?

4. Now assume that Coed Scents’ internal audit team learned through a special data analytics project that intellectual property theft is a significant threat for outsourced production. The team estimates that if Coed Scents outsources its production, it will need to spend $350,000 to manage intellectual property theft of its Two AM brand by competitors operating in the country where the outsourced production occurs. Which alternative is more cost effective and by how much?

Jack’s Lumber Yard receives 8,000 large trees each period that it subsequently processes into rough logs by stripping off the tree bark and leaves (i.e., one tree equals one log). Jack’s then must decide whether to sell its rough logs (for use in log cabin construction) at split-off or to process them further into refined lumber (for use in regular construction framing). Jack’s normally sells logs for a per-unit price of $495. Alternately, each log can be processed further into 800 board feet of lumber at an additional cost of$0.15 per board foot. Also, lumber can be sold for $0.75 per board foot.

1. What is the contribution to income from selling the logs for log cabin construction?

2. What is the contribution to income from processing the logs into lumber?

3. Should Jack’s continue to sell the logs or process them further into lumber?

A fast-food chain estimates that if it opens a restaurant in a shopping center, the probability that the restaurant is successful is 0.72. A successful restaurant earns an annual profit of $120,000; a restaurant that is not successful loses$36,000. What is the expected gain to the chain if it opens a restaurant in a shopping center?

Chillmax Company plans to sell 3,500 pairs of casual shoes at $60 each in the coming year. Product costs include:

$$\begin{array}{lr} \text{Direct materials per pair}& \$ 12\\ \text{Direct labor per pair}&4\\ \text{Variable factory overhead per pair} &2\\ \text{Total fixed factory overhead} &30,000\\ \end{array}$$

Variable selling expense is a commission of $3 per pair; fixed selling and administrative expense totals$48,000.

1. Calculate the total variable cost per unit.

2. Calculate the total fixed expense for the year.

3. Prepare a contribution margin income statement for Chillmax Company for the coming year.

Parker Pottery produces a line of vases and a line of ceramic figurines. Each line uses the same equipment and labor; hence, there are no traceable fixed costs. Common fixed cost equals $30,000. Parker’s accountant has begun to assess the profitability of the two lines and has gathered the following data for last year:

$$\begin{array}{lcc} & \text { Vases } & \text { Figurines } \\ \hline \text { Price } & \$ 40 & \$ 70 \\ \text { Variable cost } & 30 & 42 \\ \text { Contribution margin } & \$ 10& \$28\\ \text { Number of units } & 1,000 &500\\ \end{array}$$

1. Compute the number of vases and the number of figurines that must be sold for the company to break even.

2. Parker Pottery is considering upgrading its factory to improve the quality of its products. The upgrade will add $5,260 per year to total fixed cost. If the upgrade is successful, the projected sales of vases will be 1,500, and figurine sales will increase to 1,000 units. What is the new break-even point in units for each of the products?

Medina Company produces a single product. The projected income statement for the coming year is as follows:

$$\begin{array}{cr} \text { Sales } (40,000 \text{ units @ } \$45) & \$ 1,800,000 \\ \text { Total variable cost } & \underline {1,044,000 } \\ \text { Contribution margin } & \$ 756,000 \\ \text { Total fixed cost } & \underline {733,320} \\ \text { Operating income } & \underline {\underline {\$ 22,680 }} \\ \end{array}$$

(Note: Round all dollar answers to the nearest dollar. Round contribution margin ratio and degree of operating leverage to two decimal places.)

Required:

1. Compute the break-even sales dollars.

2. Compute the margin of safety in sales dollars.

3. Compute the degree of operating leverage. (Note: Round answer to two decimal places.)

4. Compute the new operating income if sales are $20 \%$ higher than expected. (Note: Round answer to the nearest dollar.)

Suppose that Chillmax Company now sells both pairs of shoes and fabric carryalls. The pairs of shoes are priced at $60 and have variable costs of$21 each. The carryalls are priced at $36 and have variable costs of$9 each. Total fixed cost for Chillmax as a whole equals $91,500 (includes all fixed factory overhead and fixed selling and administrative expense). Next year, Chillmax expects to sell 3,500 pairs of shoes and 875 carryalls.

1. Form a package of shoes and carryalls based on the sales mix expected for the coming year.

2. Calculate the break-even point in units for pairs of shoes and for carryalls.

3. Check your answer by preparing a contribution margin income statement.