Question

Viena is a regional firm that offers audit, tax, and consulting services. The partners are concerned about the profitability of their audit business, and a closure decision might be forthcoming. If the firm drops the audit activities, it might do more tax work. Only 30 percent of facility costs associated with auditing disappears by dropping the auditing function. More tax work can increase tax revenues by 40 percent, but tax service-level costs also increase by 40 percent. Total facility cost is unchanged whether or not tax work is increased. Segmented income statements for these three product lines follow.

                                                                            Auditing              Tax                  Consulting

        Sales                                                            $300,000            $500,000             $600,000

      Service-level cost                                       $250,000            $300,000            $350,000

      Shared facility cost                                       $50,000              $60,000               $80,000

        Operating income (loss)                                        $0            $140,000             $170,000

Determine which alternative Viena should choose: (1) keep the auditing (2) drop the auditing line without increasing tax work or (3) drop auditing and increase tax work. (10 points)

Please show your with explanations of how you solved for the values !

Answer 1

1) If Viena chooses to keep the auditing work then the profit from auditing will be zero(0) and the overall profit will be (140,000+170,000) = $310,000

2) If Viena chooses to drop auditing work and not to increase the tax work then the profitability will be :

Profit from tax work : $ 140,000

Profit from consultancy : $ 170,000

70% of facilities cost of auditing still exists : ($ 35,000)

Total profit : 275,000

3) Drop auditing and increase tax work

	Tax	Consultancy
Sales revenue	500,000 + 40% = 700,000	600,000
Service level cost	300,000 + 40% = 420,000	350,000
Shared facility cost	60,000	80,000
Operating income	220,000	170,000

Profit from tax work $ 220,000

Profit from consultancy work $ 170,000

70% of auditing facilities cost still exist ( $ 35,000)

Total profit $ 355,000

As the overall profit under option 3 i,e., discontinue audit and increase tax work is maximum, this option should be selected.

Answer : drop auditing and increase tax work.

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