Question

Members of the board of directors of have received the following operating income data for the year just​ ended:

Safety Step Income Statement For the Year Ended May 31, 2018,


Product Line
Industrial Household
Systems Systems Total
Net Sales Revenue $310,000 $330,000 640,000
Cost of Goods Sold
Variable 33,000 48,000 81,000
Fixed 230,000 68,000 298,000
Total Cost of Goods Sold 263,000 116,000 379,000
Gross Profit 47,000 214,000 261,000
Selling and Administrative Expenses
Variable 68,000 72,000 140,000
Fixed 43,000 28,000 71,000
Total Selling and Administrative Expenses 111,000 100,000 211,000
Operating Income (Loss) $(64,000) $114,000 $50,000


Members of the board are surprised that the industrial systems product line is losing money. They commission a study to determine whether the company should discontinue the line. Company accountants estimate that dropping industrial systems will decrease the fixed cost of goods sold by $82,000 and decrease fixed selling and administrative expenses by $15,000.

Required:
a. Prepare a differential analysis to show whether Safety Step should drop the industrial systems product line.
b. Prepare contribution margin income statements to show Safety Step's total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives' income numbers to your answer to Requirement 1.
c. What have you learned from the comparison in Requirement 2?

Answer 1

a) with industrial without industrial differential

systems systems amount

sales revenue 640,000 330,000 (310,000)

variable COGS (81,000) (48,000) 33,000

fixed COGS (298,000) (216,000) 82,000

gross profit 261,000 66,000 (195,000)

variable S&A (140,000) (72,000) 68,000

fixed S&A (71,000) (56,000) 15,000

operating 50,000 (62,000) (112,000)

income

b) contribution margin income statements:

with industrial systems

Sales revenue $640,000

- Variable COGS ($81,000)

- Variable S&A ($140,000)

Contribution margin $419,000

- Fixed COGS ($298,000)

- Fixed S&A ($71,000)

Operating income $50,000

without industrial systems

Sales revenue $330,000

- Variable COGS ($48,000)

- Variable S&A ($72,000)

Contribution margin $210,000

- Fixed COGS ($216,000)

- Fixed S&A ($56,000)

Operating loss ($62,000)

c) sometimes certain product lines help to amortize fixed costs and even though they are not profitable by themselves, without them, the company's operating profits and net income could be negatively affected.