Question

Discontinue?

Chapter 8: Dropping a product line The managers at Manchester's Department Store are concerned about the operation of its sporting goods department, which has not been very successful. The following condensed income statement gives the latest year's results: Manchester Department Store Contribution Margin Income Statement For the Year Ended December 31 Product Lines Sporting Goods $480,000 $385,000 $95,000 All Other Departments $2,400,000 $1,560,000 $840,000 Totals Sales Revenue $2,880,000 $1.945,000 $935,000 Less: Variable Costs: Contribution Margin Less: Fixed Costs Manufacturing OH Marketing & Admin. Operating Income (loss) $77,500 $48,000 $(30,500) $336,000 $240,000 $264,000 $413,500 $288,000 $233,500 none of the fixed costs can be avoided, should Manchester discontinue the sporting goods department?

Answer 1

Answer: Manchester should not discontinue the sporting goods department. Reason: While deciding whether to drop a product line or not, firm must consider relevant revenues and costs only. As it is given that none of the fixed costs can be avoided if sporting goods department is dropped, fixed manufacturing OH and fixed marketing & admin. costs are irrelevant costs as these costs would continue to incur even if the sporting goods department is dropped. The segment income statement clearly shows that the sporting goods department is capable of generating positive contribution margin. It means that operating income of sporting goods department would have been positive if fixed costs are not allocated. Therefore, if sporting goods department is dropped, firm will lose contribution margin generated by it, which is not a good decision. So, Manchester should not discontinue the sporting goods department.