Question

 Anderson Document Services, a document creation and copying company, has two departments, Design and Copying. The company's most recent monthly contribution format income statement follows:

 A study indicates that $14,000 of the fixed expenses being charged to the Design Department are sunk costs or allocated costs that will continue even if the Design Department is dropped. In addition, the

 elimination of the Design Department would result in a 5% decrease in the sales of the Copying

 Department.

 Required:

 a. Calculate the effect on the operating income of the company as a whole if the Design Department is dropped.

 b. Should the Design Department be dropped? Why or why not?

Answer 1

(a) Table showing the computation of operating income of Anderson Document Services:

Particulars	Copying Department/ Company ($)
Sales	190,000
Variable expenses	114,000
Contribution margin	76,000
Fixed expenses	32,000
Operating income (loss)	44,000

The previous operation income of the company was $57,000. If the Design Department is dropped, the operating income of the company will become $44,000. Therefore, the decision of dropping the Design Department will result in lowering the operating income of the company by $13,000.

Working Note:

1) As the Design Department is dropped, Copying Department solely constitutes the company Anderson Document Services.

2) Revised Sales = $200,000 x 95% = $190,000

Revised Variable expenses = $120,000 x 95% = $114,000

3) Fixed expenses of Copying Department is $18,000. Out of the fixed expenses of the Design Department, $14,000 is allocated costs or sunk costs. Therefore, now the total fixed costs of the company will become = $18,000 + $14,000 = $32,000

(b) No, the Design Department should not be dropped. Because dropping the same will not only result in lowering the contribution margin of the company but will also lead to a decrease in the operating income as well.