Differential Analysis for a Discontinued Product A condensed income statement by

Question

Differential Analysis for a Discontinued Product

A condensed income statement by product line for British Beverage Inc. indicated the following for Royal Cola for the past year:

It is estimated that 15% of the cost of goods sold represents fixed factory overhead costs and that 18% of the operating expenses are fixed. Since Royal Cola is only one of many products, the fixed costs will not be materially affected if the product is discontinued.

a. Prepare a differential analysis, dated March 3, 2014, to determine whether Royal Cola should be continued (Alternative 1) or discontinued (Alternative 2). If an amount is zero, enter zero "0".

Differential Analysis

Continue Royal Cola (Alt. 1) or Discontinue Royal Cola (Alt. 2)

March 3, 2014

Continue Royal Cola (Alternative 1)

Discontinue Royal Cola (Alternative 2)

Differential Effect on Income (Alternative 2)

Revenues

$

$

$

Costs:

Variable cost of goods sold

Variable operating expenses

Fixed costs

Income (Loss)

$

$

$

Sales $233,400 Cost of goods sold 112,000 Gross profit $121,400 Operating expenses 143,000 Loss from operations $(21,600)

Explanation / Answer

Fixed Costs = 15% of Cost of goods sold + 18% of operating expenses

= 15% of $112,000 + 18% of $143,000

= $42,540

So, Variable cost of goods sold = $112,000 x ( 100 - 15 )% = $95,200

and Variable Operating expenses = $143,000 x (100-18)% = $117,260

So, discontinuing the product will result in additional loss of $20,940 due to under recovery of fixed overhead. So, it is recommended to continue the product.

Particulars Continue Royal Cola (Alternative 1) Discontinue Royal Cola (Alternative 2) Differential Effect on Income (Alternative 2) Revenues 233400 0 0 Costs: Variable cost of goods sold 95200 0 0 Variable operating expenses 117260 0 0 Fixed costs 42540 42540 0 Income (Loss) -21600 -42540 -20940

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