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Chapter 25: Q25-4SE (page 1408)

Edna Fashions operates three departments: Men鈥檚, Women鈥檚, and Accessories. Departmental operating income data for the third quarter of 2018 are as follows:

EDNA FASHIONS

Income Statement

For the Quarter Ended September 30, 2018

Department

Men鈥檚 Women鈥檚 Accessories Total

Net Sales Revenue \(101,000 \)59,000 \(102,000 \)262,000

Variable Costs 65,000 35,000 91,000 191,000

Contribution Margin 36,000 24,000 11,000 71,000

Fixed Costs 27,000 19,000 29,000 75,000

Operating Income \(9,000 \)5,000 \((18,000) \)(4,000)

Assume that the fixed costs assigned to each department include only direct fixed costs of the department:

鈥� Salary of the department鈥檚 manager

鈥� Cost of advertising directly related to that department

If Edna Fashions drops a department, it will not incur these fixed costs. Under these circumstances, should Edna Fashions drop any of the departments? Give your reasoning.

Short Answer

Expert verified

Answer

Edna Fashions shoulddrop its accessories department.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Operating Income

Operating income refers to the income generated by a business from its major operations, such as revenues from sales. It is computed after deducting the variable and fixed costs from the net sales revenues.

02

Decision on continuing or dropping a segment

The decision to drop a segment is based on several factors, such as savings of variablecosts and loss of revenuesif a business drops a segment.

In the given scenario, the decision of dropping or continuing a segment is based on the incremental income/(loss).

If a business segment is generating income after deducting all the variable and fixed costs from the sales revenue, then such a segment should be continued.

As per the given data, the Men鈥檚 and Women鈥檚 department is generating revenues after recovering all the associated costs; hence the same should be carried forward.

In addition, the accessories section of the company is incurring losses, i.e., not in a state to cover associated costs. Therefore, the company should drop this segment because it is affecting the overall operating income.

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Most popular questions from this chapter

Nautical manufactures flotation vests in Tampa, Florida. Nautical鈥檚 contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units 29,000

Net Sales Revenue \(551,000

Variable Costs:

Manufacturing 116,000

Selling and Administrative 111,000

Total Variable Costs 227,000

Contribution Margin 324,000

Fixed Costs:

Manufacturing 123,000

Selling and Administrative 92,000

Total Fixed Expenses 215,000

Operating Income \)109,000

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Nautical鈥檚 decision.

2. Prepare a differential analysis to determine whether Nautical should accept this special sales order.

3. Identify long-term factors Nautical should consider in deciding whether to accept the special sales order.

StoreAll produces plastic storage bins for household storage needs. The company makes two sizes of bins: large (50 gallon) and regular (35 gallon). Demand for the products is so high that StoreAll can sell as many of each size as it can produce. The company uses the same machinery to produce both sizes. The machinery can be run for only 3,300 hours per period. StoreAll can produce 10 large bins every hour, whereas it can produce 17 regular bins in the same amount of time. Fixed costs amount to \(115,000 per period. Sales prices and variable costs are as follows:

Regular Large

Sales price per unit \)8.00 $10.40

Variable cost per unit 3.50 4.40

Requirements

1. Which product should StoreAll emphasize? Why?

2. To maximize profits, how many of each size bin should StoreAll produce?

3. Given this product mix, what will the company鈥檚 operating income be?

When completing a differential analysis, when are the differences shown as positive amounts? As negative amounts?

Cool Systems manufactures an optical switch that it uses in its final product. The switch has the following manufacturing costs per unit:

Direct materials \(5.00

Direct labor 3.00

Variable overhead 6.00

Fixed overhead 7.00

Manufacturing product cost \)21.00

Another company has offered to sell Cool Systems the switch for $15.00 per unit. If Cool Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be used for any other purpose, yet none of the fixed costs are avoidable.

Prepare an outsourcing analysis to determine whether Cool Systems should make or buy the switch.

NaturalMaid processes organic milk into plain yogurt. NaturalMaid sells plain yogurt to hospitals, nursing homes, and restaurants in bulk, one-gallon containers. Each batch, processed at a cost of \(840, yields 300 gallons of plain yogurt. NaturalMaid sells the one-gallon tubs for \)5 each and spends \(0.14 for each plastic tub. NaturalMaid has recently begun to reconsider its strategy. NaturalMaid wonders if it would be more profitable to sell individual-size portions of fruited organic yogurt at local food stores. NaturalMaid could further process each batch of plain yogurt into 6,400 individual portions (3/4 cup each) of fruited yogurt. A recent market analysis indicates that demand for the product exists. NaturalMaid would sell each individual portion for \)0.58. Packaging would cost \(0.10 per portion, and fruit would cost \)0.11 per portion. Fixed costs would not change.

Should NaturalMaid continue to sell only the gallon-size plain yogurt (sell as is) or convert the plain yogurt into individual-size portions of fruited yogurt (process further)? Why?
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