Question

Modern Company has four divisions. The budgeted revenues and expenses for each division for 2021 follows:

Division

A

B

C

D

Sales

$504,000

$948,000

$960,000

$1,240,000

Cost of goods sold

440,000

930,000

765,000

925,000

Selling & admin costs

96,000

202,500

144,000

210,000

Operating income (loss)

$(32,000)

$(184,500)

$51,000

$105,000

Further analysis of costs reveals the following percentages of variable costs in each division:

A

B

C

D

Cost of goods sold

90%

80%

90%

85%

Selling & admin costs

50%

50%

60%

60%

Closing down any division would result in a savings of 40% of the fixed costs of that division.

Required:

1. Calculate the increase or decrease in operating income if Modern Company closes division B using the below table:

Item

2. What factors should the top management of Modern Company consider before making a

Answer 1

(1) Impact on operating income if modern company close the division B:-

Current operating income of company (including division B)

Item	Amount
Division A	(32000)
Division B	(184500)
Division C	51000
Division D	105000
Overall profitability of company(loss)	(60500)

If division B is close than following impact is on operating income of company:-

Following is detail of division B:-

Item	Variable cost	Fixed cost
Cost of Goods Sold(80% variable)	744000(930000*80%)	186000(930000*20%)
Selling & admin cost(50% variable)	101250(202500*50%)	101250(202500*50%)
Total	845250(744000+101250)	287250(186000+101250)

So therefore fixed cost of division B is 287250 and 40% of which will be save if close the division B but 60% of fixed will be incurred even if close the division B. So overall impact on profit of company if division B is close is following:-

Item	Amount
Division A	(32000)
Division B(287250*60% for fixed cost which will not be save)	(172350)
Division C	51000
Division D	105000
Overall profitability of company(loss)	(48350)

So if company close the division B than loss will be 48350 and if continoue with division B than loss will be 60500 so therefore if company close the division B than 12150(60500-48350) loss will be save so it will be benefical for company to close the division B to save the loss 12150(increase in income)

(2)Factor which will be consider before close division B:-

A-Company should ensure that that variable cost of other division will not increase due to close of division B because due to redure the production it will be possible that variable cost of other division will be increase.

B-Company should analyse the resource of division B that can be allocated to other division to reduce the cost of other division.