Question

Members of the board of directors of Security Team have received the following operating income data for the year ended March 31, 2018:

SECURITY CHECK Income Statement For the Year Ended May 31, 2018

Product Line

Industrial Systems

Household Systems

Total

Net Sales Revenue	\( 300,000	\) 330,000	\( 630,000
Cost of Goods Sold:
Variable	35,000	42,000	77,000
Fixed	210,000	63,000	273,000
Total Cost of Goods Sold	245,000	105,000	350,000
Gross Profit	55,000	225,000	280,000
Selling and Administrative Expenses:
Variable	66,000	77,000	143,000
Fixed	39,000	28,000	67,000
Total Selling and Administrative Expenses	105,000	105,000	210,000
Operating Income (Loss)	\) (50,000)	\( 120,000	\) 70,000

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 drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(81,000 and decrease fixed selling and administrative expenses by \)15,000.

Requirements

1. Prepare a differential analysis to show whether Security Team should drop the industrial systems product line.

2. Prepare contribution margin income statements to show Security Team’s total operating income under the two alternatives: (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.

3. What have you learned from this comparison in Requirement 2?

Short answer

The company should not drop the industrial systems product line.

Step-by-step solution

Meaning of Income Statement

An income statement refers to the report presenting a business concern’srevenues and expenses in tabular format. Such a report is prepared annually to determine theprofits earned or losses incurredduring a particular period.

Preparation of differential analysis

Particulars	Amounts ($)
Expected decline in revenues	(300,000)
Add: Expected decline in expenses
Variable cost of goods sold	35,000
Variable selling and administrative expenses	66,000
Decrease in fixed expenses	96,000
Expected decline in operating income	$103,000

Comment:

As per the above analysis, the company should not drop the industrial systems product line because it will lead to a decrease inoperating income.

Preparation of income statement

Contribution Margin Income Statement

Particulars	With industrial system ($)	Without industrial system ($)	Difference ($)
Net sales revenue	630,000	330,000	300,000
Less: Variable costs
Cost of goods sold	(77,000)	(42,000)	(35,000)
Selling & administrative expense	(143,000)	(77,000)	(66,000)
Contribution margin	410,000	211,000	199,000
Less: Fixed costs
Cost of goods sold	(273,000)	(192,000)	(81,000)
Selling & administrative expense	(67,000)	(52,000)	(15,000)
Operating income/(loss)	$70,000	$(33,000)	$103,000

Learning from the comparison

According to the above-presented contribution margin income statement, it can be concluded that the company should not drop the industrial systems product line because it decreases the total operating income of the company by $103,000.