Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 49

Contribution Income Statement for Profit Centers; Strategy, International Stratford Corporation is a diversified company whose products are marketed both domestically and internationally. Its major product lines are pharmaceutical products, sports equipment, and household appliances. At a recent meeting, Stratford’s board of directors had a lengthy discussion on ways to improve overall corporate profitability without new acquisitions. New acquisitions are problematic because the company already has a lot of debt. The board members decided that they needed additional financial information about individual corporate operations to target areas for improvement. Dave Murphy, Stratford’s controller, has been asked to provide additional data to assist the board in its investigation. Stratford is not a public company and, therefore, has not prepared complete income statements by product line. Dave has regularly prepared an income statement by product line through contribution margin. However, he now believes that income statements prepared through operating income along both product lines and geographic areas would provide the directors with the required insight into corporate operations. Dave has the following data available:

		Product Lines
	Pharmaceutical	Sports	Appliances	Total
Production/Sales in units	160,000	180,000	160,000	500,000
Average selling price per unit	$8.00	$20.00	$15.00
Average variable manufacturing cost per unit	4.00	9.50	8.25
Average variable selling expense per unit	2.00	2.50	2.25
Fixed factory overhead excluding depreciation				$500,000
Depreciation of plant and equipment				400,000
Administrative and selling expense				1,160,000

Dave had several discussions with the division managers from each product line and compiled this

information:

• The division managers concluded that Dave should allocate fixed factory overhead on the basis of the ratio of the variable costs per product line or per geographic area to total variable costs.

• Each division manager agreed that a reasonable basis for the allocation of depreciation on plant and equipment would be the ratio of units produced per product line or per geographic area to the total number of units produced.

• There was little agreement on the allocation of administrative and selling expenses, so Dave decided to allocate only those expenses that were directly traceable to the SBU that is, manufacturing staff salaries to product lines and sales staff salaries to geographic areas. He used these data for this allocation:

Manufacturing	Staff	Sales Staff
Pharmaceutical	$120,000	United States	$ 60,000
Sports	140,000	Canada	100,000
Appliances	80,000	Europe	250,000

• The division managers provided reliable sales percentages for their product lines by geographic area:

	Percentage of Unit Sales
	United States	Canada	Europe
Pharmaceutical	40%	10%	50%
Sports	40	40	20
Appliances	20	20	60

Dave prepared this product-line income statement:

STRATFORD CORPORATION Statement of Income by Product Lines For the Fiscal Year Ended April 30, 2010
		Product Lines
	Pharmaceutical	Sports	Appliances	Unallocated	Total
Sales in units	160,000	180,000	160,000		500,000
Sales	$1,280,000	$3,600,000	$2,400,000	—	$7,280,000
Variable manufacturing
and selling costs	960,000	2,160,000	1,680,000	—	4,800,000
Contribution margin	$ 320,000	$1,440,000	$ 720,000	—	$2,480,000
Fixed costs
Fixed factory overhead	$ 100,000	$ 225,000	$ 175,000	—	$500,000
Depreciation	128,000	144,000	128,000	—	400,000
Administrative and
selling expense	120,000	140,000	80,000	$ 820,000	1,160,000
Total fixed costs	$ 348,000	$ 509,000	$ 383,000	$ 820,000	$2,060,000
Operating income (loss)	$ (28,000)	$ 931,000	$ 337,000	$(820,000)	$ 420,000

Required

1. Prepare a contribution income statement for Stratford Corporation based on the company’s geographic areas of sales.

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2. As a result of the information disclosed by both income statements (by product line and by geographic area), recommend areas on which Stratford Corporation should focus its attention to improve corporate profitability.

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3. What changes would you make to Stratford’s strategic performance measurement system? Include the role, if any, of the firm’s international business operations in your response.

(CMA Adapted)

Step 1 of 10

Contribution income statement is a tool to evaluate profit centres. It is an extension of income statement where contribution margin is arrived at for each profit centre. It goes on to further reduce traceable fixed costs directly linked to the products or production unit thus giving us contribution by profit centre. This gives us a more complete and fair measurement of performance than just overall contribution margin or operating margin.

This in turn provides sufficient details for management analysis and supports in various managerial decisions.