1.a.

The income statement mentioned in the case is based on

absorption costing and is not suitable for taking decisions. In absorption
costing, fixed and variable costs are not distinguished and we hence we
cannot deduce the impact of volume changes on profit. The present
income statement also doesnt differentiate between costs that are
traceable to a product line.
b. Using the Contribution approach would help us in decision-making.
In this approach, expenses can be classified as Variable and Fixed
costs and they can be traced to a particular product line.
2.a.
Unit selling price
Unit variable costs
Raw material
Direct labor
Variable manufacturing
overhead
Shipping expenses
Total
Unit contribution margin
Increase (decrease) in units
E-gauge: 50% on 10,000
Q-gauge: 15% on 8,000
R-gauge: 100% on 5,000
Increase (decrease) in total
Decrease (increase) in fixed
costs
Increase (decrease) in
segment contribution

Q-Gauge
$200

E-Gauge
$90

R-Gauge
$180

$31
40
45

$17
20
30

$50
60
60

10
126
$ 74

4
71
$19

10
180
$ 0

(5,000)
1,200
(5,000)
$ 88,800

$(95,000)

(100,000

80,000

40,000

$(11,200)

$(15,000)

$40,000

Based on the above calculations, we can conclude that decision to

discontinue R-gauges would be cost effective while the decisions
related to both E-gauges and Q-gauges would not be cost effective.

b. Unit contribution margin of R-gauge is $0. It does not contribute to

manufacturing overhead or promotional costs. It only covers the
variable costs. Thus, the decision to remove R- gauges was right.
c. For E-gauge, the unit contribution is $19 and Contribution per direct
labor dollar is 0.95. For Q-gauge, the unit contribution is $74 and
Contribution per direct labor dollar is 1.85.
Since the unit contribution and contribution per direct dollar is greater for
Q gauge, the president was right in promoting it. But the decision
regarding promotion expense might not be right. The decreased
promotion on the E-gauge line and the increased promotion on the Qgauge line do not produce sufficient contribution to offset the
promotional costs.
d. The 15% increase in production volume of Q- gauge will not require all
the capacity that has been generated by discontinuing R gauge or by
reducing E gauge by 50%. Capacity will not be used effectively.
2. Qualitative factors:
Labor Relations: Reduction in employment may create labor
problems.
Customer Relations: By discontinuing R gauges we might lose the
customers who are specific to R gauges.