Question

Wingate Company, a wholesale distributor of electronic equipment, has been experiencing losses for some time, as shown by its most recent monthly contribution format income statement: In an effort to resolve the problem, the company would like to prepare an income statement segmented by division. Accordingly, the Accounting Department has developed the following information: 1. Prepare a contribution format income statement segmented by divisions.

2-a. The Marketing Department has proposed increasing the West Division's monthly advertising by $15,000 based on the belief that it would increase that division's sales by 20%. Assuming these estimates are accurate, how much would the company's net operating income increase (decrease) if the proposal is implemented?

2-b. Would you recommend the increased advertising?

Answer 1

1) Image 1

2a) $27000 income increase

2b) Yes

Step-by-step explanation:

1) Ok, first of let’s segregate the sales and costs. As seen in the image in attach (the complete question), we already the contribution format income statement for the whole company. It's valuable to remember the definition: a contribution format income statement is a format of the income statement that segregates the variable and fixed expenses (as seen in the complete question image). Ok, let's divide by division (no pun intended)!

The first part is super easy: we know how much % the variable costs are relative to sales. Let's calculate then!

Division: $250000*52%=$130000

Division: $400000*30%=$120000

Division: $350000*40%=$140000

After that, we subtract those variable expenses from the sales income to find the contribution margin.

The next step is doing the same using the fixed costs (which don´t change) to find the Net Operating Income. Done! (note that the fixed expenses in this Income Statement are lower because we are considering only the traceable expenses). We then get the final table (Image 1).

2a) Now we want to see how much increasing the marketing investment (fixed expense) would contribute (or not) to the west division sales. If the estimates are accurate, we would see an increase of $70000 in sales. That would mean also an increase of $28000 in variable expenses. As fixed costs don´t change, we finally see that, in the end, if we invest $15000 in marketing, the result would be an increase of $27000 in Net Operating Income (image 2).

2b) I sure would! Even though I’m expending $15000 more in marketing, the increase in sales and ultimately in the Net Operating Income makes up for it with ease. Having that in mind, I would advise the other two divisions to research the impact they would have on sales using the same investment, especially the East Division which is giving me financial loss. If we do a quick math, if the estimates in sales increase were the same 20%, it would give me gain in both divisions, even taking into account the higher variable expenses at East Division.