Question

From textbook, Managerial Accounting, 8edition, Hartgraves and Morse. ISBN 978-1-61853-235-0, Problem p4-34

Q: Westview Eye clinic primarily performs three medical procedures: cataract removal, corneal implants and laser keratotomy. At the end of the 1st Quarter, Dr. R, president, expressed concern about the cataract sector because it had a reported loss of $100,000. he rationalized that "since the cataract market is losing $100,000 and the overall practice is making $330,000, if eleminating cataract service , the total profits would increase to $430,000."

A. Is Dr. R's analysis correct?

B. Will total profits increase if the cataract section is dropped?

C. Is it possible that total profits will decline?

Answer 1

A.

Dr. R's analysis cannot be commented upon without going into a deeper analysis of how the profits and losses of each division is computed. We would definitely need a break up of the costs associated with the cataract service to comment on this.

Overall, If Dr. R is commenting simply based on the profits of each service, without further looking into the costs, I would say that his analysis is incorrect, that the profits would rise to $430,000 straightforward.

B.

This cannot be commented upon without going into a deeper analysis of how the profits and losses of each division is computed. We would definitely need a break up of the costs associated with the cataract service to comment on this. We would need to analyse the contribution from the cataract service. If the contribution from cataract service is positive, then the profits will decrease if the cataract service is dropped. However if the contribution from cataract service is negative, then the profits will increase if the cataract service is dropped.

C.

Yes, it is possible that the total profits will decline. We need to further analyse on the costs pertaining to and allocated to the cataract service. If the contribution from cataract service is positive, then the profits will decrease if the cataract service is dropped.

Say, the fixed costs allocated to the cataract service is very high ($150,000), then the contribution from the cataract service should be a positive figure --> ($100,000) + $150,000 = $50,000. Hence if the clinic decides to do away with the cataract service, they cannot avoid the fixed costs of $150,000 but they will end of losing the positive contribution of $50,000 from the cataract service. Hence, in this example we see a clear possibility that the total profits may decline.