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Truman, Inc. Keep or Drop Division B? Errors in Evaluating.

The president of Truman, Inc., attended a seminar about the contribution margin model and returned
to her company full of enthusiasm about it. She requested that last year's traditional model income
statement be revised, and she received the following report:

Total Company A B C

Sales $466,000 $182,000 $122,000 $162,000
Variable expenses 262,000 111,000 64,000 87,000

Margin $204,000 $71,000 $58,000 $75,000
Fixed expenses 163,000 51,000 65,000 47,000

Net income (loss) $41,000 $20,000 ($7,000) $28,000

The president was told that the fixed expenses of $163,000 included $90,000 that had been split evenly
between divisions because they were general corporate expenses. After looking at the statement, the
president exclaimed, "I knew it! Division B is a drag on the whole company. Close it down!"

a. Evaluate the president's remark.
1. The president's remark ignores the misleading result of arbitrarily allocated fixed expenses.
2. The president's remark ignores the misleading results of arbitrarily allocated variable expenses.

b. Calculate what the company's net income would be if Division B were closed down.

c. What is the policy statement related to the allocation of fixed expenses.
1. Never arbitrarily allocate variable expenses.
2. Never arbitrarily allocate fixed expenses.

Solution Summary

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