Question

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

				Department
	Total			Hardware			Linens
Sales	$	4,370,000		$	3,190,000		$	1,180,000
Variable expenses		1,334,000			915,000			419,000
Contribution margin		3,036,000			2,275,000			761,000
Fixed expenses		2,200,000			1,360,000			840,000
Net operating income (loss)	$	836,000		$	915,000		$	(79,000	)

A study indicates that $378,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 13% decrease in the sales of the Hardware Department.

Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

If sale reduce by 13%, Contribution margin will also reduce by 13%.

Contribution margin of Hardware department = $ 2,275,000 - 13% = $1,979,250

Net operating income if Linens department is dropped = $1,979,250 - $1,360,000 - $378,000

= $241,250

Existing net operating income = $836,000

Financial disadvantage = $836,000 - $241,250 = $594,750