Question

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 $ 4,240,000 $ 3,190,000 $ 1,050,000 Variable expenses 1,217,000 810,000 407,000 Contribution margin 3,023,000 2,380,000 643,000 Fixed expenses 2,240,000 1,420,000 820,000 Net operating income (loss) $ 783,000 $ 960,000 $ (177,000 ) A study indicates that $378,000 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 15% 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?

Answer 1

Contribution margin lost if the Linens Department is dropped:
Lost from the Linens Department	$643,000
Lost from the Hardware Department (15% × $2,380,000)	357,000
Total lost contribution margin	1,000,000
Less fixed costs that can be avoided ($820,000 – $378,000)	442,000
Decrease in profits for the company as a whole	$558,000

The production and sale of the liens Department not be discontinued. If the liens Department is discontinued then overall profit of the company will decrease.