Question

Exercise 12-17 Dropping or Retaining a Segment [LO12-2]

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	$	4,290,000		$	3,190,000		$	1,100,000
Variable expenses		1,363,000			944,000			419,000
Contribution margin		2,927,000			2,246,000			681,000
Fixed expenses		2,190,000			1,390,000			800,000
Net operating income (loss)	$	737,000		$	856,000		$	(119,000	)

A study indicates that $380,000 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 19% decrease in the sales of the Hardware Department.

Required:

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

Answer 1

Answer

Given information:

	Total	Hardware	Linens
Sales	42,90,000	31,90,000	11,00,000
Variable expenses	13,63,000	9,44,000	4,19,000
Contribution Margin	29,27,000	22,46,000	6,81,000
Fixed Expenses	21,90,000	13,90,000	8,00,000
Net Operating income(Loss)	7,37,000	8,56,000	-1,19,000

Now, If the linen department is discontinued, the Net Operating Income of the Company will be:

Particulars	Note	Hardware
Sales	A 19% decrease in Sales	25,83,900
Variable expenses		7,64,640
Contribution Margin		18,19,260
Fixed Expenses		13,90,000
Net Operating income(Loss)		4,29,260
Add: Net Savings in Fixed Cost	due to dropping of linen dept.	420000
Net Operating income(Loss)		8,49,260

It is pertinent to note that dropping of linen department leads to a decrease of 19% in sales of Hardware Department and a savings of $420000 in fixed costs at company level.

And the overall profitability of the company increases to $849260 in comparison to $737000.

Hence, there is a Financial advantage of (849260-737000) $112260.