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 $ 4,330,000 $ 3,170,000 $ 1,160,000 Variable expenses 1,331,000 923,000 408,000 Contribution margin 2,999,000 2,247,000 752,000 Fixed expenses 2,140,000 1,310,000 830,000 Net operating income (loss) $ 859,000 $ 937,000 $ (78,000) 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 15% decrease in the sales of the Hardware Department. Required: What is the financial advantage (disadvantage) of discontinuing the Linens Department?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
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 | $ | 4,330,000 | $ | 3,170,000 | $ | 1,160,000 | |||
| Variable expenses | 1,331,000 | 923,000 | 408,000 | ||||||
| Contribution margin | 2,999,000 | 2,247,000 | 752,000 | ||||||
| Fixed expenses | 2,140,000 | 1,310,000 | 830,000 | ||||||
| Net operating income (loss) | $ | 859,000 | $ | 937,000 | $ | (78,000) | |||
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 15% decrease in the sales of the Hardware Department.
Required:
What is the financial advantage (disadvantage) of discontinuing the Linens Department?
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