Question

XYZ Comapny has three departments, Kitchen, Bath and Door. The following are the income statements of these departments: Total Bath Kitchen Door Sales Variable Expenses Contribution Margin $5,000,000 1.900.00 3.100.000 $1,000,000 300.000 700.000 $1,000,000 200.000 800.000 $3,000,000 1.400.000 1.600.000 Fixed Expenses: Depreciation Advertising Total Fixed Expenses Net operating income (loss) 2,000,000 100.000 2.100.000 $1.000.000 800.000 20.000 820.000 (120.000) 400.000 30.000 1 430.000 370.000 800,000 50.000 850.000 750.000 The elimination of the Bath Department would result in a 10% decrease in the sales of the Kitchen Department, In addition, a study indicates that depreciation expenses being charged to the Bath Department are sunk costs that will continue even if the Bath Department is dropped. However, $15,000 of advertising expenses allocated to Bath department will not continue if it is dropped. Required. 1- Prepare a schedule that shows the net operating income of the Company if the Bath Dept. is kept and the net operating income if the Bath Dept. is dropped, and the difference (Increase or decrease in operating income) 2- What is your decision, and why? Answer: Item Difference Total Before Dropping Bath Dept. Total After Dropping Bath Dept. 2- Decision:.............

Answer 1

Following is the solution to above problem :

XYZ Company Item Difference Total Before Dropping Total After Dropping Bath Dept. Bath Dept. 50,00,000 $ 39,00,000 $ -11,00,000 19,00,000 $ 15,80,000 $ -3,20,000 $ 31,00,000 $ 23,20,000 $ -7,80,000 Sales Variable Expenses Contribution Margin Fixed Expenses: Depreciation Advertising Total Fixed Expenses Net Operating Income (loss) $ 20,00,000 $ 1,00,000 $ 21,00,000 $ 10,00,000 $ 20,00,000 $ 85,000$ 20,85,000 $ 2,35,000 $ -15,000 -15,000 -7,65,000 Note: As per the question, elimination of Bath Department would result in a 10% decrease in the sale of the Kitchen Department, hence the calculation of amount after dropping Bath department has been done as per the requirement of the question. Due to 10% reduction in the sale of Kitchen Department, there will be a corresponding decrease in the variable costs too. 2 As per the above calculation, it is quite clear that if Bath department is discontinued then there will be loss of overall net operating income by $ 765000. This is so because the discontinuance of Bath department does not have any impact on fixed cost reduction of Bath department. As Deperciation cost is a sunk cost, and with elimination of Bath department does not eliminate the Sunk cost. However, the variable expenses and advertising cost to the extent of $ 15000 of Bath department will be eliminated Decision : Do not eliminate Bath Department, as it will reduce the overall income of XYZ company by $ 765000.