Question

Top managers of Markus movies and games are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this? decision:

Movies and More
Income Statement
For the Year Ended December 31, 2016
		Blu-ray	DVD
	Total	Discs	Discs
Sales Revenue	$433,000	$306,000	$127,000
Variable Costs	251,000	153,000	98,000
Contribution Margin	182,000	153,000	29,000
Fixed Costs:
Manufacturing	132,000	79,000	53,000
Selling and Administrative	70,000	55,000	15,000
Total Fixed Expenses	202,000	134,000	68,000
Operating Income (Loss)	$(20,000)	$19,000	$(39,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements

1.

Prepare a differential analysis to show whether Movies and games Movies and More should drop the DVD product line.

2.

Will dropping DVDs add $39,000 to operating ?income? Explain.

Answer 1

Part-1

Differential analysis to show whether DVD product line should be dropped or not-

Drop the DVD product line	Continue DVD product line
Sales Revenue- Nil Less Varable Costs- Nil Contribution Margin- Nil Less- Fixed Costs- $68,000 Profit/(Loss)- ($68.000)	Sales Revenue- $127,000 Less- Variable Costs- $98,000 Contribution Margin- $29,000 Less Fixed Costs- $68,000 Profit/(Loss)- ($39,000)

The analysis shows that even if we drop the DVD product line, fixed costs will continue to occur. This will result in increase in loss from $39,000 to $68,000. Hence, dropping DVD line would not be beneficial for the company.

Instead of dropping the line, company should spend on advertising and marketing expenses to increase the sales revenue of the product.

Part-2

Dropping the DVD line will not add $39,000 to operating income because the contribution of $29,000 will be lost and the fixed cost of $68,000 will continue to occur. Therefore, it will result in loss of $68,000