Question

The management of Parachute Corporation is considering dropping product ABC123. Data from the company's accounting system appear below:

Sales	$	260,000
Cost of goods sold		125,000
Building expenses		88,000
Selling and administrative expenses		75,000

All building expenses of the company are fully allocated to products in the company's accounting system. Further investigation has revealed that $42,000 of the building expenses and $48,000 of the selling and administrative expenses will not be incurred if product ABC123 is discontinued.

a. According to the company's accounting system, what are the operating profits earned by product ABC123?
b. What would be the impact on the company's overall operating profits if product ABC123 is dropped? Should the product be dropped?

Answer 1

a). Sales =     $260000
Less: COGS = $125000
Gross Profit =    $135000
Less: Building expenses = $88000
         Selling expenses =   $75000
Operating Profit =              $ (28000).
This means there is operating losss of $28000 as per company's accounting system.
If the building expense does not allocated to this product then there will be operating profit of $60000.

b). IF the product is dropped then , some expenses still going to incur, but there will be no sales and cost of goods sold.
Building expenses = $88000 - $42000 = $46000
Selling expenses = $75000 - $48000 = $27000
Total expenses= $73000
This is a loss to the company if the product is dropped, while if the product continued there is a loss of $28000. This means due to dropping of product there is a additional loss of $45000 i.e. ($73000 - $28000) . Hence the product should not be dropped.