Chapter 25: Q25-17RQ (page 1406)
Explain why a segment with an operating loss can cause the company to have a decrease in total operating income if the segment is dropped.
Answer
Dropping a segment may lead to a decrease in total operating income if such a segment has a positive contribution margin.
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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.
What are sunk costs? Give an example.
What is differential analysis?
Tread Light produces two types of exercise treadmills: regular and deluxe. The exercise craze is such that Tread Light could use all its available machine hours to produce either model. The two models are processed through the same production departments. Data for both models are as follows:
Per Unit
Deluxe Regular
Sales price \(1,030 \)610
Costs:
Direct materials 320 130
Direct labor 88 180
Variable manufacturing overhead 270 90
Fixed manufacturing overhead* 102 34
Variable operating expenses 121 63
Total costs 901 497
Operating income \(129 \)113
*allocated on the basis of machine hours
Requirements
1. What is the constraint?
2. Which model should Tread Light produce? (Hint: Use the allocation of fixed manufacturing overhead to determine the proportion of machine hours used by each product.)
3. If Tread Light should produce both models, compute the mix that will maximize operating income.
When should special pricing orders be accepted?
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