Question

Jamison Health Care is trying to decide if it should eliminate its orthopedic care division. Last year, the orthopedic division had a total contribution margin of $100,000 and allocated overhead costs of $200,000, of which $90,000 could be eliminated if the division were dropped.

On the information given, should Jamison keep the division?

And what other considerations could override a strictly financial analysis to make the decision?

Answer 1

In the given case the allocated OH cost of $110,000 (= 200,000 - 90,000) is fixed thus is a sunk cost and should not impact on our decision. We need to make a comparison of total contribution margin of $100,000 or saving $90,000 that can be eliminated. Thus,

Contribution Margin	$100,000
Minus: Avoidable Fixed Costs	$90,000
Net benefit	$10,000

As we have computed a net gain of $10,000 when the orthopedic care division operates, thus we should continue operating orthopedic care division because dropping it would not give us more saving.

The main consideration to override a strictly financial analysis are the relevant costs and avoidance of irrelevant cost to make sound business decisions on rejecting or accepting a special order, buying a product from outside or making in-house, selling a processed product or semi-finished, and shutting down or carrying on a division in business.