Question

Wasilko Corporation has two departments, Kids and Adults. The company’s most recent monthly contribution format income statement follows:

		Department
	Total	Kids	Adults
Sales	$4,200,000	$3,000,000	$1,200,000
Variable expenses	2,000,000	1,500,000	500,000
Contribution Margin	2,200,000	1,500,000	700,000
Fixed Expenses	2,200,000	1,300,000	900,000
Net operating income (loss)	0	200,000	(200,000)

A study indicates that $150,000 of the fixed expenses being charged to the Adults Department are sunk costs or allocated costs that will continue even if the Adults Department is dropped. In addition, the elimination of the Adults Department will result in a 30% decrease in the sales of the Kids Department. If the Adults Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

Answer)

Income statement if Adults department is dropped

(Amount in $)

	Department	Total
Kids	Adult
Sales	2,100,000	-	2,100,000
Variable Expenses	1,050,000	-	1,050,000
Contribution margin	1,050,000	-	1,050,000
Fixed Expenses	1,300,000	150,000	1,450,000
Net Operating Income (Loss)	(250,000)	(150,000)	(400,000)

If Adults department is dropped, the net operating loss of the company will be $ 400,000.

Working Note:

· As specified in the question, $ 150,000 of the total fixed expenses of Adults department is unavoidable in nature and will continue to incur even after the said department is dropped.

Revised Sales and variable cost of kids department if Adult department is dropped:

Revised sales = $ 3,000,000 – ($ 3,000,000 X 30%)

                        = $ 2,100,000

Revised variable cost = $ 2,100,000 X ($ 1,500,000/ $ 3,000,000)

                                      = $ 1,050,000