Question

1. Keep or Drop a Product Line: Cainas Company CPAs is a regional accounting firm that offers audit, tax, and consulting services. The partners are concerned about the profitability of their audit business, and a closure decision might be forthcoming. Facts known are as follows:

• If the firm drops it audit work, it might do more tax work. Only 30% of the fixed costs associated with auditing disappear by dropping the audit function.
• More tax work can increase revenues by 40%, but the variable costs for tax work will also increase by 40%.
• The consulting practice will remain intact with no changes planned. The following income statements for each line of business are below:

	Auditing	Tax	Consulting
Sales	300,000	500,000	600,000
Variable costs	250,000	300,000	350,000
Fixed Costs	50,000	60,000	80,000
Net income	-	140,000	170,000

1. Compute net income if the firm decides to keep audit (make no adjustments).

2. Compute net income if the firm decides to drop the audit line, while keeping its tax practice and consulting practice the same.

3. Compute net income if the firm decides to drop audit, and increase their tax work.

4. Which decision should the firm make? And what other factors should the firm consider?

Answer 1

Answer with working is given below

Net Income Sales Variable cost Contribution Fixed cost Net Income Auditing $300,000 $250,000 $50,000 $50,000 $0 Tax $500,000 $300,000 $200,000 $60,000 $140,000 Consulting Total $600,000 $1,400,000 $350,000 $900,000 $250,000 $500,000 $80,000 $190,000 $170,000 $310,000 Net Income is $310,000 Net Income if Audit Line is dropped Sales Variable cost Contribution Fixed cost Less: Fixed cost of Auditing Net Income Tax $500,000 $300,000 $200,000 $60,000 Consulting $600,000 $350,000 $250,000 $80,000 Total $1,100,000 $650,000 $450,000 $140,000 $35,000 $275,000 Net Income is $275,000 3 Drop Audit and increase tax work Sales Variable cost Contribution Fixed cost Less: Fixed cost of Auditing Net Income Tax $700,000 $420,000 $280,000 $60,000 Consulting $600,000 $350,000 $250,000 $80,000 Total $1,300,000 $770,000 $530,000 $140,000 $35,000 $355,000 Net Income is $355,000 Overall income is higher without Audit work. Hence Audit work can be dropped Factors to consider -whether clients will switch due to non-availability of Audit - Handling clients availing multiple services - Brand image - Reallocating audit staff - Other Costs impact