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 $ 4,210,000 $ 3,170,000 $ 1,040,000
Variable expenses 1,263,000 850,000 413,000
Contribution margin 2,947,000 2,320,000 627,000
Fixed expenses 2,320,000 1,480,000 840,000
Net operating income (loss) $ 627,000 $ 840,000 $ (213,000)


A study indicates that $375,000 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 18% decrease in the sales of the Hardware Department. What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

The financial advantage (disadvantage) of discontinuing the Linens Department is $642,400.

Step-by-step explanation:

To determine the financial advantage or disadvantage of discontinuing the Linens Department, we need to consider the impact on the sales and costs of the Hardware Department. Since eliminating the Linens Department will result in an 18% decrease in the sales of the Hardware Department, we can calculate the new sales for the Hardware Department by multiplying its current sales by (100% - 18%). The new sales would be $3,170,000 * 0.82 = $2,597,400.

Next, we need to adjust the fixed expenses of the Hardware Department. The fixed expenses currently allocated to the Linens Department include $375,000 of sunk costs or allocated costs that will continue even if the Linens Department is dropped. These costs should be subtracted from the fixed expenses of the Hardware Department. The adjusted fixed expenses would be $1,480,000 - $375,000 = $1,105,000.

To calculate the net operating income or loss after discontinuing the Linens Department, we can subtract the adjusted fixed expenses from the new contribution margin of the Hardware Department. The new contribution margin would be $2,597,400 - $850,000 (variable expenses) = $1,747,400.

Finally, we subtract the new contribution margin and the net operating income of the Hardware Department. The financial advantage (disadvantage) of discontinuing the Linens Department is $1,747,400 - $1,105,000 = $642,400.