Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis The p
ID: 2463138 • Letter: K
Question
Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis
The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.
Required:
1. If Devern Assurance Company drops property insurance, by how much will income increase or decrease?
- Select your answer -IncreaseDecreaseCorrect 1 of Item 1 by $
As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.
Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
Keep
Drop
$
$
$
$
$
$
2. Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.
Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
Property Insurance
Automobile Insurance
Total
$
$
$
$
$
$
$
$
$
$
Should advertising be increased?
HideAs a supporting computation, prepare a segmented income statement for the keep-or-drop decision.
Devern Assurance Company
Keep-or-Drop For Service Firm
Segmented Income Statement
Keep
Drop
$
$
$
$
$
$
Explanation / Answer
As a supporting computation, prepare a segmented income statement for the keep-or-drop decision:
Details
Automobile insurance
Sales ($12,000,000*(1-0.12)
$ 10,560,000
Less: variable expense ($9,600,000*(1-0.12)
$ (8,448,000)
Contribution margin
$ 2,112,000
Less: Direct fixed expenses
$ (500,000)
Segment margin
$ 1,612,000
Less: common fixed expenses (allocated)
($200,000+ $1,00,000)
$ (300,000)
Operating income (loss)
$ 1,312,000
Before dropping property insurance, total company wide operating income is $1,570,000 (i.e., $1,700,000-$130,000). After dropping property insurance, Operating income reduced to $1,312,000. The reason being, unavoidable fixed expenses of $300,000 (i.e., $200,000 + $100,000) would be beard by automobile insurance alone.
It is not advisable to drop property insurance.
2.
Prepare a segmented income statement that reflects the effect of increased advertising:
Details
Property insurance
Automobile insurance
Total
Sales ($4,200,000*1.10) ; ($12,000,000*1.08)
$ 4,620,000
$ 12,960,000
$ 17,580,000
Less: variable expense ($3,830,000*1.10); ($9,600,000*1.08)
$ (4,213,000)
$ (10,368,000)
$ (14,581,000)
Contribution margin
$ 407,000
$ 2,592,000
$ 2,999,000
Less: Direct fixed expenses ($500,000+$450,000)
$ -
$ (500,000)
$ (950,000)
Segment margin
$ 407,000
$ 2,092,000
$ 2,049,000
Less: common fixed expenses (allocated)
($200,000+ $1,00,000)
$ (100,000)
$ (200,000)
$ (300,000)
operating income (loss)
$ 307,000
$ 1,892,000
$ 1,749,000
Total operating income of the company as a whole is $1,570,000 (i.e., $1,700,000-$130,000) before dropping property insurance. After changes made in advertising expenses, total operating income increased to $1,749,000. Therefore, it is advisable to make the proposed changes by increasing advertisings.
Note: It is assumed that all direct fixed expenses are advertising expense.
Details
Automobile insurance
Sales ($12,000,000*(1-0.12)
$ 10,560,000
Less: variable expense ($9,600,000*(1-0.12)
$ (8,448,000)
Contribution margin
$ 2,112,000
Less: Direct fixed expenses
$ (500,000)
Segment margin
$ 1,612,000
Less: common fixed expenses (allocated)
($200,000+ $1,00,000)
$ (300,000)
Operating income (loss)
$ 1,312,000
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