The president of Ravens, Inc., attended a seminar about the contribution margin

Question

The president of Ravens, Inc., attended a seminar about the contribution margin model and returned to her company full of enthusiasm about it. She requested that last year's traditional model income statement be revised, and she received the following report: Total Company Sales Variable expenses Contribution margin Fixed expenses Net income (loss) $430,000 $170,000 $110,000 $150,000 62,000 81,000 $178,00061,000 48,000 69,000 252,000 9.000 136.000 45.00050.000 -411000 S 42,000 S 16,000 (2,000) 28,000 The president was told that the fixed expenses of $136,000 included $96,000 that had been split evenly between divisions because they were general corporate expenses. After looking at the statement, the president exclaimed, "l knew it! Division B is a drag on the whole company. Close it down!" Required a. Evaluate the presidents remark. The president's remark ignores the misleading result of arbitrarily allocated fixed expenses. The president's remark ignores the misleading result of arbitrarily allocated variable expenses. b. Calculate what the company's net income would be if Division 8 were closed down. income without

Explanation / Answer

Solution-A;

The President exclamation deesn't consider the contribution Margin (%).

It should be noted that COntribution Margin(%) are 2nd highest in Div B.

Equal Fixed cost allocation approach is not correct since the base for Division'B' is less in terms of sale revenue and consequesntly Contribution.

So, Misleading allocation of Fixed Overheads is the one which is being ignored by President Remark

Solution- B:

If Division B is closed down, it means Total Contribution of Div A and Div C would be achievable. Total Contribution attained would be $130,000 (61,000 + 69,000). Since Fixed cost will remain same as $136,000.

Net Income = Contribution - Fixed Expenses

Net Income = $130,000 - $ 136,000 = $(6,000)

Net income would be $-6,000. IT would not be suggested to close Plant B since it will bring down the income from $ 42,000 to loss of $6,000.

Contribution Margin (%) Total Company Div A Div B Div C Contribution 178000 61000 48000 69000 Sales 430000 170000 110000 150000 Contribution Margin (%) 41.4% 35.9% 43.6% 46.0%

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