Portable seating company manufactures three sizes chairs _ smalls (S) medium (M0and large (L). the income statement has consistently indicated a net loss for the M size, and management is considering three proposals: (1) continue Size M, (2) discontinue size M and reduce total output accordingly, or (3) discontinue size M and conduct an advertising campaign to expand the sales to expand the sales of sizes of size S so that the entire plant capacity to continue to be used. If proposal 2 is selected and size M is discontinued and production curtailed, the annual fixed production costs and fixed operating expense could be reduced by $150,000 and $30,000, respectively. If proposal 3 is selected, it is anticipated that an additional annual expenditure of $90,000 for the salary of an assistant brand manager (classified as fixed operating expense) would yield an increase of 125% in size S sales volume. It is also assumed that the increased production of size S would utilize the plant facilities releases by the discontinuer of M size.

The sales and costs have been relatively stable over the past few years, and they are accepted to remain so for the foreseeable future. The income statement for the past years ended January 31, 2009, is as follows:

S / M / L
Sales / $1, 050,000 / $1,150,000 / 1,000,000 / $3,200,000
Cost of goods sold
Variable costs / 570,000 / 760,000 / 600,000 / 1,930,000
Fixed cost / 255,000 / 305,000 / 265,000 / 825,000
Total cost of goods sold / 825,000 / 1,065,000 / 865,000 / 2,755,000
Gross profit / 225,000 / 85,000 / 135,000 / 445,000
Less operating expense
Variable expense / 125,000 / 115,000 / 90,000 / 330,000
Fixed expense / 34,000 / 45,000 / 15,000 / 94,000
Total operating expense / 159,000 / 160,000 / 105,000 / 424,000
Income from operation / 66,000 / (75,000) / 30,000 / 21,000

Instruction:

1. Prepare an income statement for the past year in the variable costing format. Use the following heading:

Size

S M L Total

Data for each style should be reported through contribution margin. The fixed costs should be deducted from total contribution margin, as reported in the "Total" column to determine income from operations

.2. Based on the income statement prepared in (1) and other data presented above, determine the amount by which total annual income from operations would be reduced below its present level if proposal 2 is accepted.

Annual income from operations would be reduced below its present level by $95,000 if Size M were to be discontinued (Proposal 2), as indicated below:

Contribution margin for Size M...... $275,000

Less reduction in fixed production costs and fixed operating

expenses ($150,000 + $30,000)...... 180,000

Reduction in annual income from operations...... $ 95,000

If Size M is discontinued, $275,000 of contribution margin would be forgone and only $180,000 in fixed costs would be saved, resulting in a decrease of $95,000 in income from operations.

3. Prepare an income statement in the variable costing format, indicating the projected annual income from operation if proposal 3 is accepted. Use the following headings:

Size

S L Total

Data for each style should be reported through contribution margin. The fixed cost should be deducted from the total contribution as reported in the "Total "column. For purposes of this problem, the additional expenditure of 90,000 for the assistant brand manager's salary can be added to fix operating expenses.

4. By how much would total annual income increase above its presented level if proposal 3 is accepted? Explain.

$78,750

A comparison of the amount of income from operations under pre-sent conditions,

as indicated in (1), and under Proposal 3, as indicated in (3), suggest an increase of

$78,750 if Proposal 3 is accepted, as illustrated below.

Income from operations, Proposal 3...... $99,750

Income from operations, present conditions...... 21,000

Increase in income from operations...... $78,750

Alternatively, the $78,750 increase can be determined as follows:

Contribution margin, Size S, Proposal 3...... $798,750

Contribution margin, Size S, present operations...... 355,000

Increase in contribution margin...... $443,750

Less contribution margin, Size M, present operations $275,000

Additional salaries...... 90,000 365,000

Increase in income from operations...... $ 78,750