Question

Bed & Bath, a retailing company, has two departments, Hardware and Linens. The company’s most recent monthly contribution format income statement follows: Department Total Hardware Linens Sales $ 4,110,000 $ 3,090,000 $ 1,020,000 Variable expenses 1,246,000 831,000 415,000 Contribution margin 2,864,000 2,259,000 605,000 Fixed expenses 2,140,000 1,340,000 800,000 Net operating income (loss) $ 724,000 $ 919,000 $ (195,000) A study indicates that $380,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 19% decrease in the sales of the Hardware Department. Required: If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

Answer:

If linen department is dropped operating income of the company will decrease.

Explanation:

That is because the cotrollable margin of the department is positive:

controllable margin = contribution margin - controllable fixed costs

$605,000-($800,000-380,000) = 185,000

That means that the Linen department helps to reduced fixed cost that are not generated by this department and that will keep existing wether the department is closed or not.

In addittion the Hardware department will loose 19% of its sales if the Linen department is closed. Thus will result in a reduction of the cntribution margin of the hardware deparment too.

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