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.