Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis The p

Question

Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis

The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

Required:

1. If Devern Assurance Company drops property insurance, by how much will income increase or decrease?

by $

As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

Devern Assurance Company

Keep-or-Drop For Service Firm

Segmented Income Statement

Keep

Drop

$

$

$

$

$

$

2. Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.

Devern Assurance Company

Keep-or-Drop For Service Firm

Segmented Income Statement

Property Insurance

Automobile Insurance

Total

$

$

$

$

$

$

$

$

$

$

Should advertising be increased?

Hide

As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

Devern Assurance Company

Keep-or-Drop For Service Firm

Segmented Income Statement

Keep

Drop

$

$

$

$

$

$

Explanation / Answer

1) Segmented Income Statement under two alternatives:

Devern Assurance Company

Keep-or-Drop For Service Firm

Segmented Income Statement

If Devern Assurance Company drops property insurance, the income will decrease by (1,870,000 - 1,612,000) $258,000.

Note: Unavoidable Fixed cost (i.e allocated or common fixed cost is irrelevant for decision)

2) Segmented income statement that reflects the effect of increased advertisement.

Devern Assurance Company

Keep-or-Drop For Service Firm

Segmented Income Statement

Yes, the advertisement be increased due segment margin increase by $179,000 ($2,049,000 - $1,870,000)

KEEP ($) DROP ($) SALES 16,200,000 10,560,000 Less. Variable Cost 13,430,000 8,448,000 Contribution margin 2,770,000 2,112,000 Less: Avoidable Fixed cost (Direct Fixed cost) 900,000 5,00,000 Operting income ( or segement Margin) 1,870,000 1,612,000

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