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The following monthly segmented income statement is for Condiment Company, which has three separate product lines...

  1. The following monthly segmented income statement is for Condiment Company, which has three separate product lines (A, B, and C).

A

B

C

Total

Sales revenue

$37,500

$50,000

$12,500

$100,000

Variable costs

$16,000

$27,500

$5,000

$48,500

Contribution margin

$21,500

$22,500

$7,500

$51,500

Direct fixed costs

$19,500

$16,000

$3,500

$39,000

Allocated fixed costs

$3,750

$5,000

$1,250

$10,000

Profit (loss)

$(1,750)

$1,500

$2,750

$2,500

Management is concerned about the losses associated with product line A and is considering dropping this product line. Allocated fixed costs are assigned to product lines based on sales. If product line A is eliminated, total allocated fixed costs are assigned to the remaining product lines, and all variable and direct fixed costs for product line A will be eliminated.

  1. Perform differential analysis of these two alternatives (keep product line A or drop it).
  1. Which alternative is best? Explain.
  2. Explain why the loss shown for product line A in the segmented income statement might be misleading to management.
business   accounting   
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Answer #1

Answer a

The financial disadvantage in continuing the Product A = $ 2,000 ($ 2500- $ 500)

If Product A is continued
A B C Total
Sales revenue $ 37,500 $ 50,000 $ 12,500 $ 100,000
Variable costs $ 16,000 $ 27,500 $   5,000 $   48,500
Contribution margin $ 21,500 $ 22,500 $   7,500 $   51,500
Direct fixed costs $ 19,500 $ 16,000 $   3,500 $   39,000
Allocated fixed costs $   3,750 $   5,000 $   1,250 $   10,000
Profit (loss) $ (1,750) $   1,500 $   2,750 $      2,500
If Product A is discontinued
A B C Total
Sales revenue $          -   $ 50,000 $ 12,500 $   62,500
Variable costs $          -   $ 27,500 $   5,000 $   32,500
Contribution margin $          -   $ 22,500 $   7,500 $   30,000
Direct fixed costs $          -   $ 16,000 $   3,500 $   19,500
Allocated fixed costs $   3,750 $   5,000 $   1,250 $   10,000
Profit (loss) $ (3,750) $   1,500 $   2,750 $         500

Answer b

The best alternative is to continue Product A. Because the profit is more by $ 2,000.

Answer c

The loss is misleading because it considers all the fixed costs. The Allocated fixed costs are irrelevant and should not be considered.

In case of any doubt, please comment.

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