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	$	4,200,000		$	3,120,000		$	1,080,000
Variable expenses		1,250,000			840,000			410,000
Contribution margin		2,950,000			2,280,000			670,000
Fixed expenses		2,140,000			1,310,000			830,000
Net operating income (loss)	$	810,000		$	970,000		$	(160,000	)

A study indicates that $375,000 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 11% decrease in the sales of the Hardware Department.

Required:

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

Answer 1

	Financial Disadvantage		=	$       - 465,800
	Workings:
		Total	If Linen Department discountinued	Differential amount
	Sales	$        42,00,000	$           27,76,800	$     -14,23,200
Less:	Variable expense	$        12,50,000	$              7,47,600	$         5,02,400
	Contribution margin	$        29,50,000	$           20,29,200	$       -9,20,800
Less:	Fixed expenses	$        21,40,000	$           16,85,000	$         4,55,000
	Net operating Income	$          8,10,000	$              3,44,200	$       -4,65,800
		If Linen Department discountinued
	Sales	3120000*(1-0.11)
	Variable expense	840000*(1-0.11)
	Fixed expenses	1310000+375000