Question

The following monthly segmented income statement is for V & T Faces, Inc.:

	Foundation	Blush	Eye shadow	Total
Sales Revenue	$20,000	$15,000	$23,000	$58,000
Variable Costs	11,000	8,000	9,000	28,000
Contribution Margin	9,000	7,000	14,000	30,000
Direct Fixed Costs	3,000	1,500	8,500	13,000
Allocated Fixed Costs	2,000	5,000	3,000	10,000
Profit	4,000	500	2,500	7,000

Management is concerned about the low profit associated with the blush product line and is considering dropping this product line. Allocated fixed costs are assigned to product lines based on shelf space used by each product line (measured in square feet), resulting in the following percentages for foundation, blush, and eye shadow, respectively: 20 percent, 50 percent, and 30 percent. If the blush product line is eliminated, total allocated fixed costs will be assigned as follows: 62.5 percent to foundation, and 37.5 percent to eye shadow. All variable and direct fixed costs for the blush product line will be eliminated.

Required:

Perform differential analysis. Assume keeping all product lines is Alternative 1 and dropping the blush product line is Alternative 2.

• Which alternative is best? Explain.
• Summarize the result of dropping the blush product.
• Assume the space available from dropping the blush product line can be used by the eye shadow product line, resulting in increased revenues for eye shadow of $12,000 and increased variable costs for eye shadow of $4,000. No additional direct fixed costs would be incurred, and 80 percent of allocated fixed costs would be assigned to eye shadow and 20 percent assigned to foundation.
  • Should the company drop the blush product line and use the freed-up space to expand the eye shadow product line? Alternative 1 assumes all product lines are kept and Alternative 2 assumes the blush product line is dropped with a corresponding expansion of the eye shadow product line.

Answer 1

Answer is given below