Alberta Gauge Company Ltd. a small manufacturing company in Calgary Alberta manufactures threetypes of electrical gauges used in a variety of machinery. For many years the company has been profitableand has operated at capacity. However in the last two years prices on all gauges were reduced andselling expenses increased to meet competition and keep the plant operating at capacity. Second-quarterresults for the current year which follow typify recent experience.ALBERTA GAUGE COMPANY LTD.Income StatementSecond Quarter(in thousands)Q-Gauge E-Gauge R-Gauge TotalSales ………………………………………………………………………. $1 600 $900 $ 900 $3 400Cost of goods sold …………………………………………………….. 1 048 770 950 2 768Gross margin ……………………………………………………………. $ 552 $130 $ (50) $ 632Selling and administrative expenses ………………………………. 370 185 135 690Income before taxes …………………………………………………… $ 182 $ (55) $(185) $ (58)Alice Carlo the company’s president is concerned about the results of the pricing selling andproduction prices. After reviewing the second-quarter results she asked her management staff toconsider the following three suggestions:• Discontinue the R-gauge line immediately. R-gauges would not be returned to the product lineunless the problems with the gauge can be identified and resolved.• Increase quarterly sales promotion by $100 000 on the Q-gauge product line in order to increasesales volume by 15 percent.• Cut production on the E-gauge line by 50 percent and cut the traceable advertising and promotionfor this line to $20 000 each quarter.Jason Sperry the controller suggested a more careful study of the financial relationships to determinethe possible effects on the company’s operating results of the president’s proposed course ofaction. The president agreed and assigned JoAnn Brower the assistant controller to prepare an analysis.Brower has gathered the following information.• All three gauges are manufactured with common equipment and facilities.• The selling and administrative expense is allocated to the three gauge lines based on average salesvolume over the past three years.• Special selling expenses (primarily advertising promotion and shipping) are incurred for eachgauge as follows:Quarterly Advertisingand Promotion Shipping ExpensesQ-gauge ……………………………………………………………………. $210 000 $10 per unitE-gauge ……………………………………………………………………. 100 000 4 per unitR-gauge ……………………………………………………………………. 40 000 10 per unit• The unit manufacturing costs for the three products are as follows:Q-Gauge E-Gauge R-GaugeDirect material ……………………………………………………………………… $ 31 $17 $ 50Direct labor ………………………………………………………………………….. 40 20 60Variable manufacturing overhead ……………………………………………… 45 30 60Fixed manufacturing overhead …………………………………………………. 15 10 20Total …………………………………………………………………………………… $131 $77 $190• The unit sales prices for the three products are as follows:Q-gauge …………………………………………………………………….. $200E-gauge …………………………………………………………………….. 90R-gauge …………………………………………………………………….. 180• The company is manufacturing at capacity and is selling all the gauges it produces.Required:1. JoAnn Brower says that Alberta Gauge Company’s product-line income statement for the secondquarter is not suitable for analyzing proposals and making decisions such as the ones suggested byAlice Carlo. Write a memo to Alberta Gauge’s president that addresses the following points.a. Explain why the product-line income statement as presented is not suitable for analysis anddecision making.b. Describe an alternative income-statement format that would be more suitable for analysis anddecision making and explain why it is better.2. Use the operating data presented for Alberta Gauge Company and assume that the president’sproposed course of action had been implemented at the beginning of the second quarter. Thenevaluate the president’s proposal by specifically responding to the following points.a. Are each of the three suggestions cost-effective? Support your discussion with an analysis thatshows the net impact on income before taxes for each of the three suggestions.b. Was the president correct in proposing that the R-gauge line be eliminated? Explain youranswer.c. Was the president correct in promoting the Q-gauge line rather than the E-gauge line?Explain your answer.d. Does the proposed course of action make effective use of the company’s capacity?Explain your answer.3. Are there any qualitative factors that Alberta Gauge Company’s management should considerbefore it drops the R-gauge line? Explain your answer.
