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Chapter 25: Q13E (page 1412)

Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this decision:

VIDEO AVENUE

Income Statement

For the Year Ended December 31, 2018

Total Blu-ray Discs DVD Discs

Net Sales Revenue \(437,000 \)308,000 \(129,000

Variable Costs 250,000 154,000 96,000

Contribution Margin 187,000 154,000 33,000

Fixed Costs:

Manufacturing 132,000 76,000 56,000

Selling & Administrative 65,000 51,000 14,000

Total Fixed Expenses 197,000 127,000 70,000

Operating Income (Loss) \)(10,000) \(27,000 \)(37,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements

1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line.

2. Will dropping DVDs add $37,000 to operating income? Explain.

Short Answer

Expert verified

Dropping the DVD product line will not add $37,000 to theoperating income of the company.

Step by step solution

01

Meaning of Operating Income

Operating income refers to the revenue generation,less associated expenses from the core activities of a business concern. It mainly includes thesale and purchase of goods and services and related costs.

02

Preparation of differential analysis 

Particulars

Details

Blu-ray Discs ($)

Total ($) Blu-ray & DVD Disc

Differential amount ($)

Net sales

308,000

437,000

(129,000)

Less: Variable cost

(154,000)

(250,000)

(96,000)

Contribution

154,000

187,000

(33,000)

Less: Fixed cost

Manufacturing

(76,000+56,000)

(132,000)

(132,000)

0

Selling and administrative expense

(51,000+14,000)

(65,000)

(65,000)

0

Total fixed cost

197,000

197,000

Operating income/(loss)

(43,000)

(10,000)

(33,000)

03

Consequences of dropping the DVD product line

The product line of the DVD discs will not add $37,000 to the company鈥檚 operating income because the fixed cost associated with DVD discs will remain the same (i.e., $70,000), irrespective of the change in the product line.

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Most popular questions from this chapter

Members of the board of directors of Security Check have received the following operating income data for the year ended May 31, 2018:

SECURITY CHECK

Income Statement

For the Year Ended May 31, 2018

Product Line

Industrial Systems

Household Systems

Total

Net Sales Revenue

\( 360,000

\) 380,000

\( 740,000

Cost of Goods Sold:

Variable

37,000

47,000

84,000

Fixed

260,000

63,000

323,000

Total Cost of Goods Sold

297,000

110,000

407,000

Gross Pro铿乼

63,000

270,000

333,000

Selling and Administrative Expenses:

Variable

64,000

73,000

137,000

Fixed

44,000

26,000

70,000

Total Selling and Administrative Expenses

108,000

99,000

207,000

Operating Income (Loss)

\) (45,000)

\( 171,000

\) 126,000

Members of the board are surprised that the industrial systems product line is not profitable. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(80,000 and decrease fixed selling and administrative expenses by \)12,000.

Requirements

1. Prepare a differential analysis to show whether Security Check should drop the industrial systems product line.

2. Prepare contribution margin income statements to show Security Check鈥檚 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鈥� income numbers to your answer to Requirement 1.

3. What have you learned from the comparison in Requirement 2?

Snappy Plants operates a commercial plant nursery where it propagates plants for garden centers throughout the region. Snappy Plants has \(5,100,000 in assets. Its yearly fixed costs are \)650,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.90. Snappy Plants鈥檚 volume is currently 500,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.25 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.

Requirements

1. Snappy Plants鈥檚 owners want to earn a 11% return on investment on the company鈥檚 assets. What is Snappy Plants鈥檚 target full product cost?

2. Given Snappy Plants鈥檚 current costs, will its owners be able to achieve their target profit?

3. Assume Snappy Plants has identified ways to cut its variable costs to \(1.75 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?

4. Snappy Plants started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Snappy Plants does not expect volume to be affected, but it hopes to gain more control over pricing. If Snappy Plants has to spend \)105,000 this year to advertise and its variable costs continue to be $1.75 per unit, what will its cost-plus price be? Do you think Snappy Plants will be able to sell its plants to garden centers at the cost-plus price? Why or why not?

Refer to Exercise E25-18. Cool Systems needs 79,000 optical switches. By outsourcing them, Cool Systems can use its idle facilities to manufacture another product that will contribute $225,000 to operating income.

Requirements

1. Identify the expected net costs that Cool Systems will incur to acquire 79,000 switches under three alternative plans: make the switches, buy the switches and leave facilities idle, buy the switches and use the idle facilities to make another product.

2. Which plan makes the best use of Cool System鈥檚 facilities? Support your answer.

When is nonfinancial information relevant?

Mary Tan is the controller for Duck Associates, a property management company in Portland, Oregon. Each year, Tan and payroll clerk Toby Stock meet with the external auditors about payroll accounting. This year, the auditors suggest that Tan consider outsourcing Duck Associates鈥檚 payroll accounting to a company specializing in payroll processing services. This would allow Tan and her staff to focus on their primary responsibility: accounting for the properties under management. At present, payroll requires 1.5 employee positions鈥攑ayroll clerk Toby Stock and a bookkeeper who spends half her time entering payroll data in the system.

Tan considers this suggestion, and she lists the following items relating to outsourcing payroll accounting:

  1. The current payroll software that was purchased for \(4,000 three years ago would not be needed if payroll processing were outsourced.

  2. Duck Associates鈥� bookkeeper would spend half her time preparing the weekly payroll input form that is given to the payroll processing service. She is paid \)450 per week.

  3. Duck Associates would no longer need payroll clerk Toby Stock, whose annual salary is \(42,000.

  4. The payroll processing service would charge \)2,000 per month.

Requirements

1. Would outsourcing the payroll function increase or decrease Duck Associates鈥� operating income?

2. Tan believes that outsourcing payroll would simplify her job, but she does not like the prospect of having to lay off Stock, who has become a close personal friend. She does not believe there is another position available for Stock at his current salary. Can you think of other factors that might support keeping Stock, rather than outsourcing payroll processing? How should each of the factors affect Tan鈥檚 decision if she wants to do what is best for Duck Associates and act ethically?
See all solutions

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