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Using Accounting Information In Decision Making

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Ontario Pump Company, a small manufacturing company in Toronto, manufactures 3 types of pumps used in a variety of applications. For many years the company has been profitable and has operated at capacity. However, in the last two years prices on all pumps were reduced and selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter results for the current year, which follow, typify recent experience.

ONTARIO PUMP COMPANY
Income Statement...

Maria Carlo, the company's president, is concerned about the results of the pricing, selling, and production prices. After reviewing the second-quarter results she asked her management staff to consider the following 3 suggestions:

1) Discontinue the S-Pump line immediately. S-Pump would not be returned to the product line unless the problems with the pump can be identified and resolved.
2) Increase quarterly sales promotion by $300,000 on the R-Pump product line in order to increase sales volume by 15%.
3) Cut production on the F-Pump line by 50%, and cut the traceable advertising and promotion for this line to $60,000 each quarter.

Justin Sperry, the controller, suggested a more careful study of the financial relationships to determine the possible effects on the company's operating results of the president's proposed course of action. The president agreed and assigned JoAnn Brower, the assistant controller, to prepare an analysis. Brower has gathered the following information...

REQUIRED:
1) JoAnn Brower says that Ontario Pump Company's product-line income statement for the 2nd quarter is not suitable for analyzing proposals and making decisions such as the ones suggested by Maria carlo. Write a memo to Ontario Pump's president that addresses the following points:
a) Explain why the product-line income statement as presented is not suitable for analysis and decision making.
b) Describe an alternative income-statement format that would be more suitable for analysis and decision making, and explain why it is better.

2) Use the operating data presented for Ontario Pump Company and assume that the president's proposed course of action had been implemented at the beginning of the second quarter. Then evaluate the president's proposal by specifically responding to the following points:
a) Are each of the 3 suggestions cost-effective? Support your discussion with an analysis that shows that net impact on income before taxes for each of the 3 suggestions.
b) Was the president correct in proposing that the S-Pump line be eliminated? Explain your answer.
c) Was the president correct in promoting the R-Pump line rather than the F-Pump 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 Ontario Pump Company's management should consider before it drops the S-Pump line? Explain your answer.
CHECK KEY: C14-62
2. a. Unit contribution margin, F-Pump: $57
2.c. Contribution per direct-labor dollar, R-Pump: 1.85

Please see attached for all information.

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a) Explain why the product-line income statement as presented is not suitable for analysis and decision making.

The product line income statement as presented is not suitable nor analysis and decision making since it does not tell us about the direct costs and allocated costs. Costs which are direct will not be incurred, if the line is closed but the allocated costs will continue to be incurred. In closing a line, the savings would only be in direct costs and not allocated costs. The allocated costs would now be borne by the existing lines and their costs will now change.

b) Describe an alternative income-statement format that would be more suitable for analysis and decision making, and explain why it is better.

For the purpose of analysis, we should move to an income statement with contribution margin. The contribution margin gives the amount left after all the variable costs have been covered. This amount is then available for coverage of fixed costs. A decision to ...

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