Question

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

VIDEO AVENUE

Income Statement

For the Year Ended December 31, 2018

Total Blu-ray Discs DVD Discs

Net Sales Revenue \(437,000 \)308,000 \(129,000

Variable Costs 250,000 154,000 96,000

Contribution Margin 187,000 154,000 33,000

Fixed Costs:

Manufacturing 132,000 76,000 56,000

Selling & Administrative 65,000 51,000 14,000

Total Fixed Expenses 197,000 127,000 70,000

Operating Income (Loss) \)(10,000) \(27,000 \)(37,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements

1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line.

2. Will dropping DVDs add $37,000 to operating income? Explain.

Short answer

Dropping the DVD product line will not add $37,000 to theoperating income of the company.

Step-by-step solution

Meaning of Operating Income

Operating income refers to the revenue generation,less associated expenses from the core activities of a business concern. It mainly includes thesale and purchase of goods and services and related costs.

Preparation of differential analysis 

Particulars	Details	Blu-ray Discs ($)	Total ($) Blu-ray & DVD Disc	Differential amount ($)
Net sales		308,000	437,000	(129,000)
Less: Variable cost		(154,000)	(250,000)	(96,000)
Contribution		154,000	187,000	(33,000)
Less: Fixed cost
Manufacturing	(76,000+56,000)	(132,000)	(132,000)	0
Selling and administrative expense	(51,000+14,000)	(65,000)	(65,000)	0
Total fixed cost		197,000	197,000
Operating income/(loss)		(43,000)	(10,000)	(33,000)

Consequences of dropping the DVD product line

The product line of the DVD discs will not add $37,000 to the company’s operating income because the fixed cost associated with DVD discs will remain the same (i.e., $70,000), irrespective of the change in the product line.