Question

Top managers of are alarmed by their operating losses. They are considering dropping the laminate flooring product line. Company accountants have prepared the following analysis to help make this​ decision:
Total Blue-Ray Discs DVD Discs
Sales Revenue $432,000 $305,000 $127,000
Variable Costs $246,000 $150,000 $96,000
Contribution Margin $186,000 $155,000 $31,000
Fixed Costs:
Manufacturing $128,000 $71,000 $57,000
Selling and Administrative $67,000 $52,000 $15,000
Total Fixed Costs $195,000 $123,000 $72,000
Operating Income (loss) $(9000) $32,000 $(41,000)


Total fixed costs will not change if the company stops selling DVDs.

Required:
a. Prepare a differential analysis to show whether Movie Street should drop the DVD product line.
b. Will dropping DVDs add $41,000 to the operating income? Explain.

Answer 1

Answer:

a)

                               Blue-ray discs       Blue-ray discs         Differential

                               and DVD discs      only                          amount

Sales Revenue           $432,000             $305,000             $127,000

Variable Costs           ($246,000)           ($150,000)            ($96,000)

Contribution M.           $186,000              $155,000              $31,000

Fixed Costs:

• Manufacturing   ($128,000)            ($128,000)             $0
• S&A expenses    ($67,000)             ($67,000)              $0

Operating Income         ($9000)              ($40,000)             $31,000

b) Will dropping DVDs add $41,000 to the operating income?

No, dropping the DVDs product line will decrease operating income by $31,000, resulting in a total loss of $40,000. Even though the DVDs product line by itself is not profitable, it absorbs a large percentage of the fixed costs and if you get rid of it, all the fixed costs will be absorbed by the Blue-rays product line.