Question

 E25-13 Making decisions about dropping a product 

Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the .5(33,000) following analysis to help make this decision: 

Answer 1

Solution 1:

Differential Analysis - Continue or discontinue DVD Product Line
Particulars	Continue DVD Product Line (Alt 1)	Discontinue DVD Product Line (Alt2)	Financial advantage (Disadvantage) (Alt 2)
Sales	$437,000.00	$308,000.00	-$129,000.00
Variable costs	$250,000.00	$154,000.00	-$96,000.00
Contribution margin	$187,000.00	$154,000.00	-$33,000.00
Fixed Costs:
Manufacturing	$132,000.00	$132,000.00	$0.00
Selling and administrative	$65,000.00	$65,000.00	$0.00
Net Operating income	-$10,000.00	-$43,000.00	-$33,000.00

As there is net financial disadvantage therefore DVD product line should not be dropped.

Solution 2:

Dropping DVD will be not add $37,000 to operating income because fixed cost are unavoidable, company continue to incur total fixed cost after dropping DVD Line. In fact, dropping DVD line will result in loss of contribution margin of $33,000 provided by DVD line.