Bed & Bath, a retailing company, has two departments, Hardware and Linens. The c

Question

Bed & Bath, a retailing company, has two departments, Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

Department

A study indicates that $373,000 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 16% decrease in the sales of the Hardware Department.

If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

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 $ 4,140,000 $ 3,020,000 $ 1,120,000   Variable expenses 1,365,000 953,000 412,000   Contribution margin 2,775,000 2,067,000 708,000   Fixed expenses 2,240,000 1,370,000 870,000   Net operating income (loss) $ 535,000 $ 697,000 $ (162,000 )

A study indicates that $373,000 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 16% decrease in the sales of the Hardware Department.

Required:

If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Explanation / Answer

Revised sale of the hardware depratment = $3020000 - 16% * $3020000 = $2536800

Revised Variable cost of hardware department = $ 953000 - 16% * $953000 = $800520

Revised fixed cost

= Total Fixed cost - Avoidable Fixed cost if the Linen department clsoed down

= $ 2240000 - ($870000 - $ 373000)

= $ 1743000

If the Linens Department is dropped the net operating income will decrease by

= $535000 - (-6720) = $541720

Income statement of Hardware department ($) Sales 2536800 Variable expenses 800520 Contribution 1736280 Fixed Cost (2240000-870000+373000) 1743000 Net Operating Income (6720)

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