Question

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	$	4,150,000		$	3,040,000		$	1,110,000
Variable expenses		1,367,000			952,000			415,000
Contribution margin		2,783,000			2,088,000			695,000
Fixed expenses		2,290,000			1,470,000			820,000
Net operating income (loss)	$	493,000		$	618,000		$	(125,000	)

A study indicates that $374,000 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 13% decrease in the sales of the Hardware Department.

Required:

If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

• All working forms part of the answer
• When Liner will be dropped, sales revenue, variable cost and hence contribution margin will be ZERO. However, the allocated cost will tend to be incurred.
• As a result:

		Department
	Total	Hardware	Linens
Sales	$                       2,644,800.00	$         2,644,800.00	$                                    -
Variable expenses	$                           828,240.00	$             828,240.00	$                                    -
Contribution margin	$                       1,816,560.00	$         1,816,560.00	$                                    -
Fixed expenses	$                       1,844,000.00	$         1,470,000.00	$                   374,000.00
Net operating income (loss)	$                           (27,440.00)	$             346,560.00	$                (374,000.00)

---Working for above:

	Department
	Hardware	Linens
Sales	=3040000-(3040000*13%)	0
Variable expenses	=952000*2644800/3040000	0
Contribution margin	Sales – Variable expenses	Sales – Variable expenses
Fixed expenses	1470000	374000
Net operating income (loss)	Contribution – Fixed expenses	Contribution – Fixed expenses

• Answer

Net Income when Linen was not dropped = $ 493,000 (total)

Net Income (Loss) when Linen is dropped = $ (27,440)

Hence, If Linen is dropped, The Net Income of the company will DECREASE by $ 520,440 [$ 493,000 – $ (27440)] as a whole.