Prepare and use contribution margin statements for discontinuing a line decision
ID: 2561762 • Letter: P
Question
Prepare and use contribution margin statements for discontinuing a line decision (Learning Objective 4) Members of the board of directors of Security Alliance have received the following operating income data for the year just ended: P8-50A Security Alliance Product Line Contribution Margin Income Statement For the Year Product lines Industrial Systems Household Systems Company Total 380,000 690,000 78,000 $(2,000) 268,000 $ 266,000 132,000 Less cost of goods sold: 9 Variab 10 Gross profit 11-Less marketing and administrative expenses: 12 Variable 13 Fixed 32,000 280,000 46 66.000 63,000 37000 69,000 23.000 176,000S 50,000 Operating income (loss) 15 Members of the board are surprised that the industrial systems product line is losing money. They commission a study to determine whether the company should discontinue the line. Company accountants estimate that discontinuing the industrial systems line will decrease fixed cost of goods sold by $80,000 and decrease fixed marketing and administrative expenses by $11,000 Requirements 1. Prepare an incremental analysis to show whether Security Alliance should discontinue the industrial systems product line. 2. Prepare contribution margin income statements to show Security Alliance's total operating income under the two altermatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives income numbers to your answer to Requirement 1. What have you learned from this comparison?Explanation / Answer
Solution 1 Let's calculate the relevant cost Sale revenue 310,000 Cost of goods sold Less Variable cost (32,000) Less Fixed relevant cost (80,000) Gross profit 198,000 Marketting and administrative expense Less Variable cost (63,000) Less Fixed relevant cost (11,000) Operating Income 124,000 Since considering relevant cost, industrial systems is giving positive cash flow, it is not advisable to discontinue the product line Solution 2 Contribution statement With Industrial system Without Industrial system Sale revenue 690,000 380,000 Variable cost (210,000) (115,000) Contribution Margin 480,000 265,000 Less Fixed cost (406,000) (315,000) Operating profit 74,000 (50,000) As we can see the profits are down by 124000 without industrial system which exactly is the one calculated in solution 1. This represents, we can not see the profit numbers to take any decision We need to look at the relevant cost of running or discontinuing an operation.