Question

Problem 6-28B Eliminating a segment

Pam’s Grocery Store has three departments—meat, canned food, and produce—each of which has its own manager. All departments are housed in a single store. Recently, the produce department has been suffering a net loss and is expected to continue doing so. Last year’s income statements follow:

	Meat Department	Canned Food Department	Produce Department
Sales	$ 350,000	$ 320,000	$ 237,500
Cost of goods sold	(160,000)	(190,000)	(147,500)
Gross margin	190,000	130,000	90,000
Departmental manager’s salary	(21,000)	(15,000)	(17,500)
Rent on store lease	(40,000)	(40,000)	(40,000)
Store utilities	(10,000)	(10,000)	(10,000)
Other general expenses	(49,000)	(49,000)	(49,000)
Net income (loss)	$ 70,000	$   16,000	$ (26,500)

Required

Determine whether to eliminate the produce department.

Confirm the conclusion you reached in Requirement a by preparing a before and an after income statement, assuming that the produce department is eliminated.

Eliminating the produce department would allow the meat department to expand. It could add seafood to its products. Suppose that management estimates that offering seafood would increase the store’s net earnings by $80,000. Would this information affect the decision that you made in Requirement a? Explain your answer.

Answer 1

Income statement before eliminating Produce department is as follows:

The company is having an overall net income of $ 59,500 without eliminating the Produce Department.

Income statement after eliminating Produce department is as follows:

The company is having a net loss if the produce department is eliminated. the net loss is $ 13,000. The fixed expenses of Rent on store lease, store utilities and other general expenses would incur eventhough Produce department is eliminated as they are common expenses allocated equally among the departments.

Therefore, it is recommended not to eliminate the produce department to not let the company to go into losses.

But, If management is assuming of an increase in net earnings by $ 80,000 due to additional sales of seafood, the Net income of the firm would be $ 67,000 ( $ 80,000 - $ 13,000). This is greater than the net income earned by keeping the produce department.

Therefore, in this case, it is feasible to eliminate the produce department.

Hope this is helpful!!