Differential Analysis for a Discontinued Product
A condensed income statement by product line for Warrick
Beverage Inc. indicated the following for Mango Cola for the past
year:
Sales | $15,000,000 |
Cost of goods sold | (10,800,000) |
Gross profit | $4,200,000 |
Operating expenses | (8,000,000) |
Operating loss | $(3,800,000) |
It is estimated that 30% of the cost of goods sold represents fixed factory overhead costs and that 25% of the operating expenses are fixed. Because Mango Cola is only one of many products, the fixed costs will not be materially affected if the product is discontinued.
a. Prepare a differential analysis dated February 29 to determine whether Mango Cola should be continued (Alternative 1) or discontinued (Alternative 2). If an amount is zero, enter "0". If required, use a minus sign to indicate a loss.
Differential Analysis | |||
Continue (Alt. 1) or Discontinue (Alt. 2) Mango Cola | |||
February 29 | |||
Continue Mango Cola (Alternative 1) |
Discontinue Mango Cola (Alternative 2) |
Differential Effects (Alternative 2) |
|
Revenues | $ | $ | $ |
Costs: | |||
Variable cost of goods sold | |||
Variable operating expenses | |||
Fixed costs | |||
Profit (Loss) | $ | $ | $ |
Answer-
WARRICK BEVERAGE INC. | |||
DIFFERENTIAL ANALYSIS | |||
ALTERNATIVE 1 | ALTERNATIVE 2 | DIFFERENTIAL EFFECT | |
CONTINUE MANGO COLA | DISCONTINUE MANGO COLA | ||
PARTICULARS | $ | $ | $ |
Sales | 15000000 | 0 | -15000000 |
Less- Variable costs | |||
Cost of goods sold | $10800000*70%= $7560000 | 0 | 7560000 |
Operating expenses | $8000000*75%= $6000000 | 0 | 6000000 |
Contribution margin | 1440000 | -1440000 | |
Less- Fixed costs | |||
Factory overhead | $10800000*30%= $3240000 | 3240000 | 0 |
Operating expenses | $8000000*25%= $2000000 | 2000000 | 0 |
Net operating income (loss) | -3800000 | -5240000 | -1440000 |
Hence the company should not discontinue its mango cola product line otherwise the company will loss it profit by $1440000.
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