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Memorandum 
Date: 


Today 

To: 

Alice Carlo, President, Alberta Gauge Company, Ltd. 

From: 

I.M. Student 

Subject: 

Suggested revision of product-line income statement 

a. The product-line income statement presented is not suitable for analysis and 
decision making. The statement does not distinguish between variable and fixed 
costs, which hinders any analysis on the impact of volume changes on profit. In 
addition, the statement does not distinguish between costs that are directly 
related (traceable) to a product line from those that are shared among all 
products. 

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Chapter 14 - Decision Making: Relevant Costs and Benefits 

b. An alternative income statement format that would be more suitable for analysis 
and decision making would incorporate the contribution approach. Expenses 
would be classified in terms of variability and controllability such as: variable 
manufacturing, variable selling and administrative, direct fixed controllable by 
segment, direct fixed controllable by others, and common fixed. The common 
fixed costs would not be assigned to the product lines because such an 
allocation would be arbitrary. The contribution approach is more suitable for 
analysis and decision making because there is a meaningful assignment of costs 
to product lines. 
2. 

a. The suggested discontinuance of the R-gauges would be cost effective, but the 
suggestions relating to E-gauges and Q-gauges would not be cost effective. 
These conclusions are based on the following quarterly analysis. 

CASE 14-63 (CONTINUED) 

Unit selling price .............................. 
Unit variable costs 
Raw material ................................. 
Direct labor ................................... 
Variable manufacturing 
overhead ..................................... 
Shipping expenses ....................... 
Total ........................................... 
Unit contribution margin ................. 

E-Gauge 

R-Gauge 
$180 

$17 
20 

$31 
40 

$50 
60 

30 
4 

45 
10 

60 
10 

Increase (decrease) in units* 
E-gauge: 10,000 × 50% .............. 
Q-gauge: 8,000 × 15% ............... 
R-gauge: 5,000 × 100% .............. 
Increase (decrease) in total 
contribution margin ....................... 
Decrease (increase) in fixed costs 
Increase (decrease) in segment 
contribution .................................... 

71 
$19 

× (5,000) 

126 
$ 74 

× 1,200 

180 
$ 0 

× (5,000) 

$(95,000) 
80,000† 

– $20,000 
14-45 

$ 88,800 
(100,000) 

$ 

$(15,000) 

*Unit sales = sales dollars ÷ unit sales price 
†$100,000 

$90 

Q-Gauge 
$200 

0 
40,000 

$(11,200) 

$40,000 

Chapter 14 - Decision Making: Relevant Costs and Benefits 

b. Yes, the president was correct in eliminating the R-gauges. The R-gauge sales 
price covers only its variable cost and does not contribute anything to 
manufacturing overhead or promotion costs. Thus, the R-gauge has a zero
contribution margin. 
c. Yes, the president was correct in promoting the Q-gauge line rather than the Egauge line, because the unit contribution margin and contribution per labor 
dollar is greater for the Q-gauge line as follows: 

Unit contribution ........................................................... 
Contribution per direct-labor dollar ............................ 

E-Gauge 
$19.00 
.95 

Q-Gauge 
$74.00 
1.85 

CASE 14-63 (CONTINUED) 
However, the president’s decisions regarding promotion expense do not seem 
well conceived. The decreased promotion on the E-gauge line and the increased 
promotion on the Q-gauge line do not produce sufficient contribution to offset 
the promotional costs. 
d. No. The proposed course of action does not make effective use of capacity. The 
15 percent increase in production volume on the Q-gauge line will not require all 
of the capacity that has been released by discontinuing the R-gauge line or
reducing the E-gauge line by 50 percent. 
3. 

Yes. The qualitative factors that management should consider before it decides 
whether to drop the R-gauge line include: 
• Customer relations. The sale of E-gauges and Q-gauges may be related to the 
sale of R-gauges. 
• Labor relations. Reducing employment may create labor problems. 

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Chapter 14 - Decision Making: Relevant Costs and Benefits 

FOCUS ON ETHICS (See page 617 in the text.) 
This scenario addresses the effects of a decision to outsource, and as a result, close a 
department. 
Edgeworth is not acting ethically in asking Mint to withhold the ABC costing analysis 
data from Mello. To do so would be tantamount to deliberately risking that the company 
will incur unnecessary costs, which in turn could affect profitability negatively. 
Edgeworth is putting the well-being of himself and family above of the company’s best 
interests in making this request. 
Mint is correct to point out that the decision about how much weight should be placed 
on the ABC numbers, and how much on related issues of morale, quality and reliability, 
should derive from a “full and open discussion” with all the relevant parties present. In 
order that Edgeworth is well-prepared for this discussion, the outcome of which may 
greatly affect his organization, it is appropriate that Mint share the data with him ahead 
of that meeting. Mint should also provide the same data to any other interested party 
ahead of the meeting to promote a well-informed discussion of the topic. Doing so will 
facilitate a rational discussion and a sound decision to be reached at the meeting. 
[Final version]