Question

CoolE Ltd. produces two types of air-conditioning divisions: Conventional and Eco-friendly. For many years the company has been profitable and has operated at full capacity. However, for the last two years, prices on all air conditioners have been reduced and selling expenses increased to meet competition and to keep the plant operating at capacity. The company is considering disposing of the Eco-friendly division since it has been consistently unprofitable over the last two years. The following results for the last year ended December 31, 2020typify the recent experience:

	Conventional Division	Eco-friendly Division	Total
Sales	$1,870,000	$750,000	$2,620,000
Cost of goods sold*	1,100,000	600,000	1,700,000
Gross profit	770,000	150,000	920,000
Selling & administrative expenses**	395,000	210,000	605,000
Net income	$375,000	-$60,000	$315,000
Note that:
*70% variable and 30% fixed
**35% variable and 65% fixed

The managing director of the company thinks that discontinuing the Eco-friendly division immediately will save $80,000 of fixed cost of goods sold and $95,000 of fixed selling expenses.

Daniel Nguyen, the management accountant, suggested a more careful study of the financial relationships to determine the possible effects on the company’s operating results of the managing director’s proposed course of action. The managing director agreed and assigned you, as assistant accountant, to prepare an analysis.

Required:

a)​Determine whether the company should discontinue the operation of the Eco-friendly division by preparing an incremental analysis.

b)​If the company had discontinued the division for 2020, determine what net income would have been.

c)​Suggest and explain any other issues that CoolE’s management should consider before it drops the Eco-friendly division.

Answer 1