Question

In: Accounting

Exercise 12-17 Dropping or Retaining a Segment [LO12-2] Bed & Bath, a retailing company, has two...

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?

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Expert Solution

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.


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