Question

Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis

Devern Assurance Company provides both property and automobile insurance. The projected income statements for the two products are as follows:

	Property Insurance		Automobile Insurance
Sales	$4,200,000		$12,000,000
Less variable expenses	3,830,000		9,600,000
Contribution margin	$370,000		$2,400,000
Less direct fixed expenses	400,000		500,000
Segment margin	$(30,000)		$1,900,000
Less common fixed expenses (allocated)	100,000		200,000
Operating income (loss)	$(130,000)		$1,700,000

The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

Required:

1. If Devern Assurance Company drops property insurance, by how much will income increase or decrease?

Decrease  by $

As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
	Keep	Drop
Sales	$	$
Less variable expenses
Contribution margin	$	$
Less direct fixed expenses
Segment margin	$	$

2. Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.

Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
	Property Insurance	Automobile Insurance	Total
Sales	$	$	$
Less variable costs
Contribution margin	$	$	$
Less direct fixed expenses
Segment margin	$	$	$
Less common fixed costs
Operating income			$

Should advertising be increased?

Yes

Answer 1

	Property Insurance	Automobile Insurance	Total
Sales	4,200,000	12,000,000	16,200,000
Less: variable expenses	3,830,000	9,600,000	13,430,000
Contribution margin	370,000	2,400,000	2,770,000
Less: direct fixed expenses	400,000	500,000	900,000
Segment margin	(30,000)	1,900,000	1,870,000
Less: common fixed expenses (allocated)	100,000	200,000	300,000
Operating income (loss)	(130,000)	1,700,000	1,570,000

Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
	Keep	Drop	Remark for Drop
Sales	16,200,000	10,560,000	12000000*88%
Less: variable expenses	13,430,000	8,448,000	9600000*88%
Contribution margin	2,770,000	2,112,000
Less: direct fixed expenses	900,000	500,000
Segment margin	1,870,000	1,612,000
If Devern Assurance Company drops property insurance, then Income decrease by		258,000
As per above data, Company should not Drop Property Insurance because income will decrease by 258000

	Property Insurance	Remarks	Automobile Insurance	Remarks	Total
Sales	4,620,000	4200000*110%	12,960,000	12000000*108%	17,580,000
Less: variable expenses	4,213,000	3830000*110%	10,368,000	9600000*108%	14,581,000
Contribution margin	407,000		2,592,000		2,999,000
Less: direct fixed expenses			500,000		500,000
Segment margin	407,000		2,092,000		2,499,000
Less: common fixed expenses (100000+200000+450000)					750,000
Operating income (loss)					1,749,000
As per above data, advertising should be increased.