Question

Thalassines Kataskeves, S.A., of Greece makes marine equipment. The company has been experiencing losses on its bilge pump product line for several years. The most recent quarterly contribution format income statement for the bilge pump product line follows:

Thalassines Kataskeves, S.A. Income Statement—Bilge Pump For the Quarter Ended March 31
Sales				$	460,000
Variable expenses:
Variable manufacturing expenses	$	132,000
Sales commissions		52,000
Shipping		19,000
Total variable expenses					203,000
Contribution margin					257,000
Fixed expenses:
Advertising (for the bilge pump product line)		27,000
Depreciation of equipment (no resale value)		120,000
General factory overhead		34,000	*
Salary of product-line manager		113,000
Insurance on inventories		8,000
Purchasing department		51,000	†
Total fixed expenses					353,000
Net operating loss				$	(96,000	)

*Common costs allocated on the basis of machine-hours.

†Common costs allocated on the basis of sales dollars.

Discontinuing the bilge pump product line would not affect sales of other product lines and would have no effect on the company’s total general factory overhead or total Purchasing Department expenses.

Required:

What is the financial advantage (disadvantage) of discontinuing the bilge pump product line?

Answer 1

Depreciation, general factory overhead, and purchasing department are unavoidable costs; therefore, irrelevant for decision making. These costs should not be considered.

If these are removed the new fixed cost becomes,

New fixed cost = Earlier fixed cost – Depreciation – General factory overhead – Purchasing department

                              = 353,000 – 120,000 – 34,000 – 51,000

                              = $148,000

Net operating income = Contribution margin – New fixed cost

                                    = 257,000 – 148,000

                                    = $109,000

Since there is income but no loss, discontinuing the product line would give disadvantage. Such disadvantage is the loss of income of $109,000.