Question

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

Total Department
Hardware Linens
Sales $ 4,200,000 $ 3,120,000 $ 1,080,000
Variable expenses 1,359,000 946,000 413,000
Contribution margin 2,841,000 2,174,000 667,000
Fixed expenses 2,270,000 1,450,000 820,000
Net operating income (loss) $ 571,000 $ 724,000 $ (153,000)


A study indicates that $378,000 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 17% decrease in the sales of the Hardware Department.



Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

Discontinuing the Linens Department would result in a financial advantage of $8,420 for the company.

Step-by-step explanation:

To determine the financial advantage or disadvantage of discontinuing the Linens Department, we need to consider the impact it will have on the company's net operating income. From the given information, we know that the Linens Department currently has a net operating loss of $153,000.

However, $378,000 of the fixed expenses being charged to the Linens Department are sunk costs or allocated costs that will continue even if the department is dropped. This means that discontinuing the Linens Department would result in a decrease of fixed expenses by $378,000.

In addition, the elimination of the Linens Department would lead to a 17% decrease in the sales of the Hardware Department. Given that the Hardware Department currently has a contribution margin of $2,174,000, the 17% decrease in sales would reduce the contribution margin by $369,580 (17% of $2,174,000).

Therefore, the financial advantage (disadvantage) of discontinuing the Linens Department can be calculated as:

Net Operating Income Benefit = Decrease in Linens fixed expenses + Decrease in Hardware contribution margin

Net Operating Income Benefit = $378,000 - $369,580

Net Operating Income Benefit = $8,420

Based on this calculation, discontinuing the Linens Department would result in a financial advantage of $8,420 for the company.