Question

Suire Corporation is considering dropping product D14E. Data from the company's accounting system appear below: Sales $740,000 Variable expenses $341,000 Fixed manufacturing expenses $257,000 Fixed selling and administrative expenses $205,000 All fixed expenses of the company are fully allocated to products in the company's accounting system. Further investigation has revealed that $199,500 of the fixed manufacturing expenses and $114,500 of the fixed selling and administrative expenses are avoidable if product D14E is discontinued. a. According to the company's accounting system, what is the net operating income earned by product D14E? (Net losses should be indicated by a minus sign.) b. What would be the financial advantage (disadvantage) of dropping product D14E? Should the product be dropped?

Answer 1

Answer:

See explanation.

Explanation:

In order to find the profitability of D14E we only calculate relevant costs which are incremental and thus can be avoided if D14E was not produced. However as the system allocates complete costs we will take the allocated costs for the first part.

1)

Sales                           $740,000

Less:

Variable expenses      $341,000

Fixed Manufacturing    $257,000

Fixed Selling                 $205,000

Loss as/ system            $ -63,000

2)

First we see if the product D14E has positive contribution to fixed costs,

Contribution = Revenue - Variable costs

Contribution D14E = 740,000 - 341,000 = $399,000

The contribution is positive so now we compare it to avoidable fixed costs,

Total Advantage forgone = Contribution - avoidable fixed costs

Advantage forgone = 399,000 - 199,500 - 114,500 = $85,000

Since the product covers all its variable cost and provides a positive contribution even after covering avoidable fixed costs, it should not be dropped as it would be a disadvantage of revenue forgone by $85,000.

Hope that helps.

Answer 2

Answer:

a, NET OPERATING INCOME EARNED BY PRODUCT D14E

                                                                                     $

Sales                                                                       740,000                                                                                

Less: variable expenses                                         341,000

Contribution                                                             399,000

Less: Fixed manufacturing expenses                     257,000

Less:Fixed selling and administrative expenses  205,000                                                                                                                                        

Net operating income                                              (63,000)  

b. If product D14E is dropped, the operating income of the company reduces by $85,000

c. NET CONTRIBUTION OF PRODUCT D14E

                                                                                                     $

    Sales                                                                                   740,000

    Less: variable cost                                                             341,000

    Contribution                                                                        399,000

    Less: Avoidable fixed manufacturing cost                        199,500

        Avoidable fixed selling and  administrative expenses  114,500

       Net contribution                                                                 85,000

The product should not be dropped because it has a positive net contribution.

Explanation:

This question relates to a decision on whether or not to drop a  product or segment. In the first part of the question, there is need to determine the net operating income ,which is a function  of sales less total cost.

The second part of the question focuses on the financial implication         of dropping product D14E.  Dropping the product will reduce the net operating income of the company by $85,000.

The third part of the question relates to whether or not the product should be dropped. In this case, we need to determine the net contribution of the product. Net contribution is obtained by the excess of sales over variable cost and avoidable fixed cost. Since the net contribution  of the product is positive, it implies that the product should not be dropped.