Assume the role of Jennifer and prepare an income statement for 2020 using variable costing. Then use information on that statement as a basis for estimating the annual impact on profit of sales to construction companies.

RainRuler Stains produces a variety of exterior wood stains that have excellent coverage and longevity. In 2020, the company produced and sold 310,000 gallons of stain. There was no beginning inventory. Income for the year was as follows: 

In the past, the company has marketed its product only to independent hardware stores in Oregon, Washington, and Idaho. Recently, however, Reggie Sherman, VP of marketing, has negotiated deals with several large construction companies. He estimates that these deals will increase annual sales by 70,000 gallons but at a reduced price of $12 per gallon. (The price in 2020 to hardware stores was $15 per gallon, and this will not be affected by the new deals.) 

At a recent meeting of the company’s senior management team, Reggie presented a rough estimate of the financial impact of selling through the new channel: 

Additional sales (gallons)....................................70,000 

Selling price per gallon.......................................$ 12.00 

Incremental revenue.......................................$840,000 

Gross profit per dollar of sales 

($1, 350, 000 ÷ $4, 650, 000)................................0.2903 

Incremental profit.............................................$243,852 

Since the incremental profit was more than two times as large as current net income, most of the managers present at the meeting expressed their hearty congratulations. Jennifer Jones, a summer intern and assistant to the company controller, Ed Flemming, thought Reggie’s estimate was more than a little rough. After the meeting, she approached her boss and expressed her misgivings. “Ed, according to our previous discussions, fixed production costs related to rent, depreciation, and other items are about $1,362,500 per year. Reggie’s analysis assumes that there aren’t any fixed manufacturing overhead items. And I know our shipping costs, which are included in selling expense, are around $0.70 per gallon. Reggie’s analysis assumes all selling expense is fixed. It’s probably the case that almost all of our administrative expense is fixed, but that’s clearly not accurate for selling expense. How about if I recast our income statement in a contribution margin format—you know, using variable costing—and use that as a basis to estimate the impact of the new channel sales?” Ed quickly agreed to Jennifer’s proposal.

Transcribed Image Text:

RainRuler Stains Income Statement For the Year Ended December 31, 2020 Sales $4,650,000 Less cost of goods sold 3,300,000 Gross profit 1,350,000 Less selling and administrative expenses: Selling expense Administrative expense $870,000 360,000 1,230,000 Net income $ 120,000