Question

Bed & Bath, a retailing company, has two departments, Hardware and Linens. The company’s most recent monthly contribution format income statement follows: Department Total Hardware Linens Sales $ 4,240,000 $ 3,140,000 $ 1,100,000 Variable expenses 1,226,000 818,000 408,000 Contribution margin 3,014,000 2,322,000 692,000 Fixed expenses 2,110,000 1,300,000 810,000 Net operating income (loss) $ 904,000 $ 1,022,000 $ (118,000) A study indicates that $379,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 14% decrease in the sales of the Hardware Department. Required: If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

Income Statement before dropping Linen Division
SEGMENT-WISE INCOME STATEMENT
				TOTAL	HARDWARE	LINEN
				AMOUNT $	AMOUNT $	AMOUNT $
Sales Revenue				4,240,000	3,140,000	1,100,000
Less: Variable cost				1,226,000	818,000	408,000
Contribution margin				3,014,000	2,322,000	692,000
Less: Fixed cost				2,110,000	1,300,000	810,000
SEGMENT MARGIN				904,000	1,022,000	-118,000
Income Statemnet after dropping
SEGMENT-WISE INCOME STATEMENT
				TOTAL	HARDWARE
				AMOUNT $	AMOUNT $
Sales Revenue				2,700,400	2,700,400	(3140000-14%)
Less: Variable cost				703,480	703,480	(818000-14%)
Contribution margin				1,996,920	1,996,920
Less: Fixed cost				1,300,000	1,300,000
SEGMENT MARGIN				696,920	696,920
Less: Rregional Administrative expense				379,000
Net Operating Income				317,920
Hence, Linen deptt should nt be dropped as it will lead to decrease in net operating income