Home Designs sells home electronics and home furnishings. Home furnishings curre

Question

Home Designs sells home electronics and home furnishings. Home furnishings currently take up 70 percent of available retail floor space. The CEO is trying to decide whether the company should continue offering home furnishings or concentrate on the more lucrative home electronics market. The most recent income statement is given below. If the home furnishings is dropped, salaries and other direct expenses can be avoided. The company estimates the home electronic sales will increase 15% without affecting direct fixed costs. Allocated fixed costs are assigned based on relative sales. Electronics Furnishings Total Sales $1,800,000 $1,500,000 $3,300,000 Less cost of goods sold 1,160,000 1,100,000 2,260,000 Contribution margin 640,000 400,000 1,040,000 Less direct fixed costs: Salaries 220,000 220,000 440,000 Other 80,000 80,000 160,000 Allocated fixed costs: Rent 65,455 54,545 120,000 Insurance 5,455 4,545 10,000 Taxes 4,364 3,636 8,000 Administrative Salaries 98,182 81,818 180,000 Other 8,182 6,818 15,000 Net income (loss) $158,362 $(51,362) $107,000

Explanation / Answer

It is mentioned in question that if home furnishing division is closed Salaries & other Direct expenses can be avoided. Hence, the company will continue to incur allocated fixed costs even after home furnishing division is closed. Accordingly, such cost become irrelevant in decision making.

From the above calculation it is clear that Home Furnishing division is earning $100,000 after deducting Direct Fixed Cost. If this division is dropped net income of Home Designs will fall by $100,000.Hence, the company should continue the division.

Home electronics Home Furnishings Total Sales 18,00,000 15,00,000 33,00,000 Cost of Goods Sold 11,60,000 11,00,000 22,60,000 Contribution Margin 6,40,000 4,00,000 10,40,000 Direct Fixed Cost: - Salaries 2,20,000 2,20,000 4,40,000 - Others 80,000 80,000 1,60,000 Net Income after direct fixed cost 3,40,000 1,00,000 4,40,000

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