Question

Edna Fashions operates three departments: Men’s, Women’s, and Accessories. Departmental operating income data for the third quarter of 2018 are as follows:

EDNA FASHIONS

Income Statement

For the Quarter Ended September 30, 2018

Department

Men’s Women’s Accessories Total

Net Sales Revenue $101,000$59,000 $102,000$262,000

Variable Costs 65,000 35,000 91,000 191,000

Contribution Margin 36,000 24,000 11,000 71,000

Fixed Costs 27,000 19,000 29,000 75,000

Operating Income $9,000$5,000 \((18,000) \)(4,000)

Assume that the fixed costs assigned to each department include only direct fixed costs of the department:

• Salary of the department’s manager

• Cost of advertising directly related to that department

If Edna Fashions drops a department, it will not incur these fixed costs. Under these circumstances, should Edna Fashions drop any of the departments? Give your reasoning.

Short answer

Answer

Edna Fashions shoulddrop its accessories department.

Step-by-step solution

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

Operating income refers to the income generated by a business from its major operations, such as revenues from sales. It is computed after deducting the variable and fixed costs from the net sales revenues.

Decision on continuing or dropping a segment

The decision to drop a segment is based on several factors, such as savings of variablecosts and loss of revenuesif a business drops a segment.

In the given scenario, the decision of dropping or continuing a segment is based on the incremental income/(loss).

If a business segment is generating income after deducting all the variable and fixed costs from the sales revenue, then such a segment should be continued.

As per the given data, the Men’s and Women’s department is generating revenues after recovering all the associated costs; hence the same should be carried forward.

In addition, the accessories section of the company is incurring losses, i.e., not in a state to cover associated costs. Therefore, the company should drop this segment because it is affecting the overall operating income.