Question

Profits have been decreasing for several years at Pegasus Airlines. In an effort to improve the company’s performance, the company is thinking about dropping several flights that appear to be unprofitable.

A typical income statement for one round-trip of one such flight (flight 482) is as follows:

Ticket revenue (165 seats × 40% occupancy × $240 ticket price)	$	15,840			100.0	%
Variable expenses ($18.00 per person)		1,188			7.5
Contribution margin		14,652			92.5	%
Flight expenses:
Salaries, flight crew	$	1,600
Flight promotion		790
Depreciation of aircraft		1,700
Fuel for aircraft		5,200
Liability insurance		4,800
Salaries, flight assistants		1,400
Baggage loading and flight preparation		1,900
Overnight costs for flight crew and assistants at destination		600
Total flight expenses		17,990
Net operating loss	$	(3,338	)

The following additional information is available about flight 482:

1. Members of the flight crew are paid fixed annual salaries, whereas the flight assistants are paid based on the number of round trips they complete.

2. One-third of the liability insurance is a special charge assessed against flight 482 because in the opinion of the insurance company, the destination of the flight is in a “high-risk” area. The remaining two-thirds would be unaffected by a decision to drop flight 482.

3. The baggage loading and flight preparation expense is an allocation of ground crews’ salaries and depreciation of ground equipment. Dropping flight 482 would have no effect on the company’s total baggage loading and flight preparation expenses.

4. If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight.

5. Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible.

6. Dropping flight 482 would not allow Pegasus Airlines to reduce the number of aircraft in its fleet or the number of flight crew on its payroll.

Required:

1. What is the financial advantage (disadvantage) of discontinuing flight 482?

Answer 1

Answer:

Financial (disadvantage) of (5062)

Explanation:

Contribution margin lost of the tour is discontinued		-14,652
Less: Flight costs that can be avoided
Flight promotion	790
Fuel for aircraft	5200
Liability insurance (4800 / 3)	1600
Salaries, flight assistants	1400
Overnight costs for flight crew and assistants at destination	600	9590
Net increase(decrease) in profits if the flight is discontinued		-5062
Financial (disadvantage) (5062)

Hence, it is not advised to drop the flight.

Note 1: Profit (loss) analysis has been prepared on the basis of the relevant cost.

Note 2: The following might be the reason behind scheduling officer’s contest about increasing occupancy: Eliminating flight may encourage passengers to opt among available option, which may lead to increase occupancy. There may be some flights which may very low occupancy, which is the main reason behind low average occupancy.