Question

Answer these 2 problems.

E8-23A Decide whether to discontinue a product line (Learning Objective 4) Top managers of Vermont Flooring are alarmed by their operating losses. They sidering dropping the laminate flooring product line. Company accountants have pared the following analysis to help make this decision: Vermont Flooring Product Line Contribution Margin Income Statement For the Year Product lines Laminate od flooring flooring Company Total 306000 128.000 434000 7 Sales revenue 156000 22.000 238000 8 Les Variable expenses 150 000 46000 1960 9 Contribution maron 10 Les fixed expenses 75.000 55.000 130.000 11 Manufacturing 51000 19.000 70.000 12 Marketing and administrative 24100015 200001 00 13 Operating income (loss Total fixed costs will not change if the company stops selling laminate flooring Requirements 1. Prepare an incremental analysis to show whether Vermont Flooring should discontinue the laminate flooring product line. Will discontinuing laminate flooring add $28.000 operating income? Explain. 2. Assume that the company can avoid $32,000 of fixed expenses by discontinuing the laminate flooring product line (these costs are direct fixed costs of the laminate flooring product line). Prepare an incremental analysis to show whether the company should stop selling laminate flooring. 3. Now, assume that all of the fixed costs assigned to laminate flooring are direct foxed costs and can be avoided if the company stops selling laminate flooring. However, marketing has concluded that wood flooring sales would be adversely affected by discontinuing the laminate flooring line (retailers want to buy both from the same sup plier). Wood flooring production and sales would decline 10%. What should the com- pany do? E8-24A Discontinuing a product line (Learning Objective 4) Suppose Smithers Company is considering discontinuing its organic dried fruit product line. Assume that during the past year, the organic dried fruit's product line income state- ment showed the following: 1 Sales revenue 2 Less: Cost of goods sold 3 Gross profit 4 Less Operating expenses 5 Operating income loss) 5.200.000 6.500.000 (1.300.000 1.500.000 227300.000 Fixed manufacturing overhead costs account for 40% of the cost of goods, while only 30% of the operating expenses are foxed. Since the organic dried fruit line is just one of the company's fruit operations, only $750,000 of direct foxed costs (the majority of which is advertising) will be eliminated if the product line is discontinued. The remainder of the fixed costs will still be incurred by the company. If the company decides to discontinue the product line, what will happen to the company's operating income? Should Smithers Company discontinue the organic dried fruit product line?

Answer 1

E8-23A

Given data

VERMONT FLOORING
Product Line Contribution Margin Income Statement
	Product Lines
	Wood Flooring	Laminate Flooring	Total
Sales Revenue	$          3,06,000	$                 1,28,000	$          4,34,000
Less: Variable Expenses	$          1,56,000	$                    82,000	$          2,38,000
Contribution Margin	$         1,50,000	$                    46,000	$          1,96,000
Less: Fixed Expenses
Manufacturing	$              75,000	$                    55,000	$          1,30,000
Marketing and Administrative	$              51,000	$                    19,000	$              70,000
Operating Income (Loss)	$              24,000	$                   (28,000)	$              (4,000)

Income Statement if the Laminate Flooring Product Line is discontinued by Vermont Flooring

VERMONT FLOORING
Product Line Contribution Margin Income Statement
	Wood Flooring
Sales Revenue	$          3,06,000
Less: Variable Expenses	$          1,56,000
Contribution Margin	$          1,50,000
Less: Fixed Expenses*
Manufacturing	$          1,30,000
Marketing and Administrative	$              70,000
Operating Income (Loss)	$            (50,000)

* It is mentioned that Fixed Expenses will not change even if the company stops selling Laminate Flooring

1. It can be seen that the Vermont Flooring is suffering a total loss of $4,000 if it is continuing with both product lines. However, the loss increases to $50,000 if the company discontinues the Laminate Flooring product line. Hence, Vermont Flooring should not discontinue the Laminate Product line.

Discontinuing Laminate Product line will not add $28,000 to the Operating Income because the fixed expenses will be incurred even if the company is not continuing with the Laminate Product line. The contribution received from the Laminate Product line reduced the total loss when both products were sold by the company. On discontinuing the Laminate Product line, the total loss increased by $46,000 which was the contribution received from the Laminate Product line.

2. The contribution received from the Laminate Product line was $46,000. If the fixed expenses of $32,000 are avoided by Vermont Flooring by discontinuing the Laminate Product line, it will still increase the loss by $12,000.

Reduction in Fixed Expenses	$              32,000
Less: Loss of Contribution from Laminate Product Line	$              46,000
Net Loss	$            (14,000)

Hence, Vermont Flooring should not discontinue the Laminate Product line if it can avoid fixed expenses of $32,000.

3. If the production and sales of the Wood flooring product line reduces by 10%, the contribution from the Wood Flooring product line will reduce by $15,000 ($150,000 x 10%). The fixed expenses for the Wood Flooring Product Line will not change due to a change in production and sales. Below incremental analysis shows the result of discontinuing the Laminate Flooring Product line if the fixed expenses are fully avoided and the production and sales of the Wood flooring product line reduces by 10%.

Reduction in Fixed Expenses	$              74,000
Less: Loss of Contribution from Laminate Flooring Product Line	$              46,000
Less: Loss of Contribution from Wood Flooring Product Line	$              15,000
Net Income	$              13,000

Hence, in this scenario, the total income of Vermont Flooring will increase by $13,000. Hence, the company should discontinue the Laminate Flooring Product Line in this scenario.

E8-24A

Given Data

SMITHERS COMPANY
Organic Dried Fruit's Product Line Income Statement
Sales Revenue	$        5,200,000
Less: Cost of Goods Sold	$        6,500,000
Gross Profit	$      (1,300,000)
Less: Operating Expenses	$        1,500,000
Operating Income (Loss)	$      (2,800,000)
Fixed Manufacturing Overhead Costs (40% of Cost of Goods Sold)	$        2,600,000
Variable Manufacturing Overhead Costs (60% of Cost of Goods Sold)	$        3,900,000
Fixed Operating Expenses (30% of Operating Expenses)	$          450,000
Variable Operating Expenses (70% of Operating Expenses)	$        1,050,000

Preparing a contribution margin product-line income statement from the above data:

SMITHERS COMPANY
Organic Dried Fruit's Contribution Margin Product Line Income Statement
Sales Revenue	$        5,200,000
Less: Variable Costs
Manufacturing Overheads	$        3,900,000
Operating Expenses	$        1,050,000
Contribution	$          250,000
Less: Fixed Costs
Manufacturing Overheads	$        2,600,000
Operating Expenses	$          450,000
Operating Income (Loss)	$      (2,800,000)

Incremental analysis of the decision to discontinue the Organic Dried Fruits product line

Reduction in Fixed Expenses	$          750,000
Less: Loss of Contribution	$          250,000
Net Income	$          500,000

As the contribution from the Organic Dried Fruits product line is less than the Fixed expenses incurred for the same product line, discontinuing the Organic Dried Fruits product line will increase the total income of Smithers Company by $500,000. Hence, the company should discontinue the Organic Dried Fruits product line.