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Important information about Dropping or Retaining a Segment

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Boyle's Home Center, a retailing company, has two departments, Bath and Kitchen. The company's most recent monthly contribution format income statement follows:

Total Bath Kitchen
Sales $ 5,000,000 $ 1,000,000 $ 4,000,000
Variable expenses 1,900,000 300,000 1,600,000
Contribution margin 3,100,000 700,000 2,400,000
Fixed expenses 2,700,000 900,000 1,800,000
Net operating income (loss) $ 400,000 $ (200,000 ) $ 600,000
A study indicates that $370,000 of the fixed expenses being charged to the Bath Department are sunk costs or allocated costs that will continue even if the Bath Department is dropped. In addition, the elimination of the Bath Department would result in a 10% decrease in the sales of the Kitchen Department.

If the Bath Department is dropped, what will be the effect on the net operating income of the company as a whole? (Input the amount as positive value. Omit the "$" sign in your response.)

in overall net operating income

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Solution Summary

The solution explains how to determine the impact on net operating income of dropping a segment

See Also This Related BrainMass Solution

Adding and Dropping Products: The Impact on the Income Statement

XY Company: Segmented Income Statement

It is important to consider the financial impact of changing the product mix (i.e., adding or dropping products). Preparing a segmented income statement for various scenarios assists management in determining the estimated financial impact of making one choice over another. The case below expands on the variable costing statement from the first module by adding more details about fixed costs (direct versus common) and showing the revenues and costs associated with each product and not just in the aggregate.

The company we are looking at in this module makes two products and is considering adding one more since the company has excess capacity. One aspect of making this decision is to screen the various scenarios to determine the potential profitability. Financial information alone does not tell us what to do, but it is a good start.

XY Company currently manufactures two products, X and Y. The company has the capacity to make one additional product, with two (Z and W) currently under consideration. The forecasted annual sales and related costs for each product are as follows.

- Sales:

Product Z: 110,000

Product W: 150,000

Variable costs

- Production (%)

Product Z: 50%

Product W: 60%

- Selling and administrative (%)

Product Z: 10%

Product W: 5%

- Direct fixed expenses

Product Z: 10,000

Product W: 12,500
See below for the income statement for last year's operations.

Product X: $275,000

Product Y: $400,000

Total Sales: $675,000

Less variable expenses

- Production

Product X: 100,000

Product Y: 200,000

Total: 300,000

- Selling and administrative

Product X: 20,000

Product Y: 60,000

Total: 80,000

- Contribution margin

Product X: $155,000

Product Y: $140,000

Total: $295,000

- Less direct fixed expenses

Product X: 10,000

Product Y: 55,000

Total: 65,000

- Segment margin

Product X: $145,000

Product Y: $85,000

Total: $230,000

- Less common fixed expenses


Net income


Common fixed costs are allocated to each product line on the basis of sales revenues.

Prepare a variable costing income statement that includes products X, Y, and Z. Repeat for products X, Y, and W. Do you recommend adding product Z or W?
Suppose that you could add both Z and W, if either X or Y is dropped. Would you drop one of the current products to add both W and Z? Support your answer with computations.
Which of the products looks the most profitable? Assuming no restraint on customer demand or resources, which product would you choose in order to maximize profitability? What about qualitative, as opposed to quantitative, concerns?
Explain the difference between the contribution margin and the segment margin and how to use the information in the decision-making process.

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