Diversified Products, Inc., has recently acquired a small publishing company that offers three books for sale—a cookbook, a travel guide, and a handy speller. Each book sells for $10. The publishing company’s most recent monthly income statement is shown below.

The following additional information is available:

a. Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the income statement above. Sales commissions are 10% of sales.

b. The same equipment is used to produce all three books, so the equipment depreciation expense has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 30% of the time to produce cookbooks, 50% of the time to produce travel guides, and 20% of the time to produce handy spellers.

c. The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is $3 per square foot per year. The warehouse contains 48,000 square feet of space, of which 7,200 square feet is used by the cookbook line, 24,000 square feet by the travel guide line, and 16,800 square feet by the handy speller line.

d. The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars.

e. The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines.

f. All other costs are traceable to the three product lines in the amounts shown on the income statement above.

The management of Diversified Products, Inc., is anxious to improve the publishing company’s 5% return on sales.

Required:

1. Prepare a new contribution format segmented income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional information provided.

2. Based on the segmented income statements given in the problem, management plans to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide. However, based on the new contribution format segmented income statement that you prepared:

a. Do you agree with management’s plan to eliminate the cookbook? Explain.

b. Do you agree with the decision to focus all available resources on promoting the travel guide? Assume that an ample market is available for all three product lines.

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Product Line Total Travel Handy Speller Company Cookbook Guide Sales . $300,000 $90,000 $150,000 $60,000 Expenses: Printing costs. Advertising.. General sales.. 102,000 27,000 63,000 12,000 36,000 13,500 19,500 3,000 18,000 5,400 9,000 3,600 Salaries.... 33,000 18,000 9,000 6,000 Equipment depreciation.. Sales commissions ... General administration.. 9,000 3,000 3,000 3,000 30,000 9,000 15,000 6,000 42,000 14,000 14,000 14,000 Warehouse rent... 12,000 3,600 6,000 2,400 Depreciation-office facilities . 3,000 1,000 1,000 1,000 Total expenses.. Net operating income (loss).... 285,000 94,500 139,500 51,000 $ 15,000 $ (4,500) $ 10,500 $ 9,000