Question

Howard Enterprises, which has three departments, recently reported the following results: A B C Sales revenue $ 12,000 $ 48,000 40,000 Less: Operating costs 11,400 59,800 50,500 Operating income (loss) $ 600 $ (11,800 ) $ (10,500 ) The company incurred variable operating costs as well as $25,000 of fixed operating costs. The $25,000 amount was allocated to A, B, and C on the basis of sales revenue and is included in the cost figures noted above. Which department(s), if any, should be closed if none of the fixed operating costs can be avoided

Answer 1

Answer:

Department C should be closed

Explanation:

To determine whether or not it will be profitable to drop a loss making department, we compare the savings in fixed cost to the lost contribution from the division.

For Howard Enterprises, the department with a negative contribution should be closed otherwise its operation would reduce the overall profit by the amount of the negative contribution.

So lets work out the contribution for each department by adding back the apportioned fixed cost. See table below

                                                           A                B                C

                                                            $                $                $             Total

Sales Revenue                               12,000      48,000        40,000    100,000

Operating cost                              11,400        59,800        50,500

Operating income                           600         (11,800)        (10,500)

*Add back apportioned fixed cost 3,000       12,000        10,000

Contribution                                   3,600        200            (500)

*Apportioned fixed cost

A- 12,000/100,000× 25,000 = 3,000

B- 48,000/100000   × 25,000 = 12,000

C- 40,000/100,00×25,000 = 10,000

From the above analysis, Department C generates a negative contribution. It implies that it can barely cover its direct cost and so will deplete the total profit by its negative contribution. Hence, it should be closed

Department C should be closed