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 $ 4,080,000 $ 3,020,000 $ 1,060,000 Variable expenses 1,321,000 909,000 412,000 Contribution margin 2,759,000 2,111,000 648,000 Fixed expenses 2,260,000 1,400,000 860,000 Net operating income (loss) $ 499,000 $ 711,000 $ (212,000 ) 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 18% decrease in the sales of the Hardware Department.

Required: What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

Answer)

Present Situation: Income statement

(Amount in $)

Particulars	Total	Hardware	Linen
Sales	4,080,000	3,020,000	1,060,000
Variable Expenses	1,321,000	909,000	412,000
Contribution margin	2,759,000	2,111,000	648,000
Fixed Expenses	2,260,000	1,400,000	860,000
Net Operating Income	499,000	711,000	(212,000)

If Linens department is discontinued: Income statement

(Amount in $)

Particulars	Total	Hardware	Linen
Sales	2,476,400	2,476,400	-
Variable Expenses	745,380	745,380	-
Contribution margin	1,731,020	1,731,020	-
Fixed Expenses	1,779,000	1,400,000	379,000
Net Operating Income	(47,980)	331,020	(379,000)

Net impact = Current Net Operating income – Net operating income if linens segment is discontinued

                      = $ 499,000 - (-47,980)

                      = $ 499,000 + $ 47,980

                      = $ 546,980

Therefore if the linens segment is discontinued, the Net operating income of the company will decline by $ 546,980. (I.e. from Net operating income of $ 499,000 the company will report loss of $ 47,980).

Working Notes:

Revised sales of Hardware department = $ 3,020,000 – (18% X $ 3,020,000)

                                                                         = $ 2,476,400

Revised Variable cost Hardware department = $ 909,000 X ($ 2,476,400/ $ 3,020,000)

                                                                         = $ 745,380