Question

Below are departmental income statements for a guitar manufacturer. The manufacturer is considering eliminating its electric guitar department since it has a net loss. The company classifies advertising, rent, and utility expenses as indirect.

WHOLESALE GUITARS
Departmental Income Statement
For year ended December 31, 2017
	Acoustic	Electric
Sales	\(112,500	\)105,500
Cost of goods sold	55,675	\(66,750
Gross profit	56,825	\)38,750
Operating expenses
Advertising expenses	8,075	6,250
Depreciation expenses – Equipment	10,150	9,000
Salaries expenses	17,300	13,500
Supplies expenses	2,030	1,700
Rent expenses	6,105	5,950
Utilities expenses	3,045	2,550
Total operating expenses	46,705	38,950
Net income (Loss)	\(10,120	(\)200)

1. Prepare a departmental contribution report that shows each department’s contribution to overhead.

2. Based on contribution to overhead, should the electric guitar department be eliminated?

Short answer

1. The combined net income of both departments is$9,920.
2. No, the business entity must not eliminate the electric guitar department.

Step-by-step solution

Definition of Contribution Margin

The profit generated by a business entity over the variable expenses incurred in the business is known as the contribution margin.

Departmental contribution report

WHOLESALE GUITARS
Departmental Income Statement
For the year ended December 31, 2017
	Acoustic	Electric	Combined
Sales	$112,500	$105,500	$218,000
Cost of goods sold	55,675	$66,750	122,425
Gross profit	56,825	38,750	95,575
Operating expenses
Depreciation expenses – Equipment	10,150	9,000	19,150
Salaries expenses	17,300	13,500	30,800
Supplies expenses	2,030	1,700	3,730
Total operating expenses	29,480	24,200	53,680
Departmental contribution to overhead	27,345	14,550	$41,895
Advertising expenses			14,325
Rent expenses			12,055
Utility expenses			5,595
Total indirect expenses			31,975
Net income			$9,920

The decision regarding electric guitar department

The electric guitar department must not be eliminated based on contribution to overhead because it is contributing $14,550 to cover the indirect expenses.