P4-35. Continue or Discontinue Lakeland Eye Clinic primarily performs three medi
ID: 2446216 • Letter: P
Question
P4-35. Continue or Discontinue
Lakeland Eye Clinic primarily performs three medical procedures: cataract removal, corneal im-
plants, and laser keratotomy. At the end of the first quarter of this year, Dr. Pathaja, president of
Lakeland, expressed grave concern about the cataract sector because it had reported a loss of
$50,000. He rationalized that “since the cataract market is losing $50,000, and the overall practice
is making $165,000, if we eliminate the cataract market, our total profits will increase to $215,000.”
Required
a. Is the president’s analysis correct?
b. Will total profits increase if the cataract section is dropped?
c. Is it possible total profits will decline?
Explanation / Answer
a. More data needed regarding the cost and revenue details before any comments are made regrading the correctness of the President's analysis. The loss of a service may happen due to negative contribution margin ( when the variable costs are more than the revenue) and the loss may also happen when contribution margin is positive but the fixed costs are more than the contribution margin. Again the correctness of the basis of allocation of Fixed costs like salary of doctors and nurses which are common to three services , rent , insurance depreciation, facility maintenance, etc will impact the correct profit reporting. So withour detailed study of contribution margin and basis of allocation of fixed costs , no conclusion can be reached.
b. If the catarct section is generating negative contribution margin and after closing the cataract section some common fixed cost will come down , then the total rpofits may increase if cataract section is dropped. However, if cataract section is generating positive contribution margin and common fixed costs do not reduce after cataract section closing , total profit will not increase after cataract section is dropped.
c. If , cataract section is generating positive contribution margin and common fixed costs do not reduce after cataract section closing , total profit will not decline after cataract section is dropped.
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