Question

1. The following monthly segmented income statement is for Condiment Company, which has three separate product lines (A, B, and C).

	A	B	C	Total
Sales revenue	$37,500	$50,000	$12,500	$100,000
Variable costs	$16,000	$27,500	$5,000	$48,500
Contribution margin	$21,500	$22,500	$7,500	$51,500
Direct fixed costs	$19,500	$16,000	$3,500	$39,000
Allocated fixed costs	$3,750	$5,000	$1,250	$10,000
Profit (loss)	$(1,750)	$1,500	$2,750	$2,500

Management is concerned about the losses associated with product line A and is considering dropping this product line. Allocated fixed costs are assigned to product lines based on sales. If product line A is eliminated, total allocated fixed costs are assigned to the remaining product lines, and all variable and direct fixed costs for product line A will be eliminated.

1. Perform differential analysis of these two alternatives (keep product line A or drop it).

2. Which alternative is best? Explain.
3. Explain why the loss shown for product line A in the segmented income statement might be misleading to management.

Answer 1

Answer a

The financial disadvantage in continuing the Product A = $ 2,000 ($ 2500- $ 500)

If Product A is continued
	A	B	C	Total
Sales revenue	$ 37,500	$ 50,000	$ 12,500	$ 100,000
Variable costs	$ 16,000	$ 27,500	$   5,000	$   48,500
Contribution margin	$ 21,500	$ 22,500	$   7,500	$   51,500
Direct fixed costs	$ 19,500	$ 16,000	$   3,500	$   39,000
Allocated fixed costs	$   3,750	$   5,000	$   1,250	$   10,000
Profit (loss)	$ (1,750)	$   1,500	$   2,750	$      2,500

If Product A is discontinued
	A	B	C	Total
Sales revenue	$          -	$ 50,000	$ 12,500	$   62,500
Variable costs	$          -	$ 27,500	$   5,000	$   32,500
Contribution margin	$          -	$ 22,500	$   7,500	$   30,000
Direct fixed costs	$          -	$ 16,000	$   3,500	$   19,500
Allocated fixed costs	$   3,750	$   5,000	$   1,250	$   10,000
Profit (loss)	$ (3,750)	$   1,500	$   2,750	$         500

Answer b

The best alternative is to continue Product A. Because the profit is more by $ 2,000.

Answer c

The loss is misleading because it considers all the fixed costs. The Allocated fixed costs are irrelevant and should not be considered.

In case of any doubt, please comment.