Analyzing Decision to Eliminate Unprofitable Segment
Sunblocker Corp. (see PA7-1 and PA7-2) is considering eliminating a product from its Happy Sand line of beach umbrellas. This collection is aimed at people who spend time on the beach or have an outdoor patio near the beach. Two products, the Happy Day and Morning Sun umbrellas, have impressive sales. However, sales for the Rolling Surf model have been dismal.
Sunblocker’s information related to the Happy Sand line follows:
Segmented Income Statement for Sunblocker’s Happy Sand Beach Umbrella Products | ||||
| Happy Day | Morning Sun | Rolling Surf | Total |
Sales Revenue | $60,000 | $60,000 | $30,000 | $150,000 |
Variable Costs | 34,000 | 31,000 | 23,000 | 88,000 |
Contribution Margin | $26,000 | $29,000 | 7,000 | $ 62,000 |
Less: Direct Fixed Costs | 1,900 | 2,500 | 1,000 | 5,400 |
Segment Margin | $24,100 | $26,500 | $ 6,000 | $ 56,600 |
Common Fixed Costs* | 17,840 | 17,840 | 8,920 | 44,600 |
Profit | $ 6,260 | $ 8,660 | $ (2,920) | $ 12,000 |
*Allocated based on total sales dollars. | ||||
Sunblocker has determined that eliminating the Rolling Surf model would cause sales of the Happy Day and Morning Sun models to increase by 10 percent and 15 percent, respectively. Variable costs for these two models would increase proportionately. However, none of the fixed cost allocated to the Rolling Surf model is avoidable. The fixed overhead currently allocated to this model would be redistributed to the remaining two products.
Required:
1. Determine what would happen to the company’s total profit if Sunblocker were to drop the Rolling Surf product. What is your recommendation to Sunblocker?
2. Suppose that Sunblocker had no direct fixed overhead in its production information and the entire $50,000 of fixed cost was common fixed cost. Would your recommendation to Sun-blocker change? Why or why not?
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