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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.

Short Answer

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Answer

Dropping a segment may lead to a decrease in total operating income if such a segment has a positive contribution margin.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Operating Income

Operating income refers tothe revenue generated by a business from its major functions. It includes the revenues generated from the sale and purchase of goods or services after deducting the related expenses.

02

Loss in a segment leading to a decrease in operating income

A dropped segment may lead to a decrease in total operating income if such a segment is has a positive contribution margin. There may be a situation where a segment has a positive contribution margin but has an operating loss. It means that such a segment is helping the company to recover some of its fixed costs, and dropping the segment will decrease the total operating income.

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Most popular questions from this chapter

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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