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				$	470,000
Variable expenses:
Variable manufacturing expenses	$	124,000
Sales commissions		40,000
Shipping		11,000
Total variable expenses					175,000
Contribution margin					295,000
Fixed expenses:
Advertising (for the bilge pump product line)		30,000
Depreciation of equipment (no resale value)		116,000
General factory overhead		32,000	*
Salary of product-line manager		125,000
Insurance on inventories		8,000
Purchasing department		51,000	†
Total fixed expenses					362,000
Net operating loss				$	(67,000	)

*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

Assumption:

1. The product manager is managing on this product line.

2. The given insurance amount is for insuring this product line only.

By Discontinuing the business the management will be able to increase the total profit of the company up to $279,000 because it can avoid the following expenses as I explain Below.

Fixed Expense	$
Advertisement (As it is only used for this particular production company can avoid the cost in future	30,000
Salary of product line manager (as there is no more production no need of a product line manager in for this product line)	125,000

Depreciation(As the company stops production they don't want to charge any more depreciation on the product.)	116,000
insurance on inventory(No inventory no Need to pay insurance)	8,000

The total increase in company net operating income

279000

But there will be a reduction in the net income from other product lines because the portion of other fixed expenses like general factory overhead and purchase department expenses currently charged against bilg pump product line will be charged against the remaining products which will reduce the net income from all other product lines by an amount of $ 83,000 As follows.

Expense	Amount $
General factory Expenses	32,000
Purchase department expenses	51,000
Total decrease is in company net income	83,000

So the final effect will be as follows

Particulars	Amount $
Gross increase in Net Operating income of company by discontinuing the product line	279,000
Gross decrease in the net operating income of company by discontinuing the product line	83,000
The net effect in the net income by discontinuing the Product line	196,000

Conclusion:

By discontinuing the product line company will get an increase in the total net operating income of $196,000