Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis The p

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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?

by $

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Prepare the segmented income statement to determine the effect of dropping the segment of the business.

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

$

$

$

$

$

$

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Prepare an income statement for the company if the property insurance were to be dropped. Compare that to the existing income statement for the entire company. Common fixed expenses are not traceable to the segments. They would remain even if one of the segments were eliminated.

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.

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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

$

$

$

$

$

$

Explanation / Answer

     1 Keep or Drop Service Firm Details Property Insurance Automobile Insurance Total Sales              4,200,000        12,000,000       16,200,000 Less Variable Expenses            3,830,000           9,600,000       13,430,000 Contribution Margin                370,000           2,400,000         2,770,000 Less Direct Fixed Expenses                400,000              500,000             900,000 Segment Margin                (30,000)           1,900,000         1,870,000 Less Common Fixed cost                100,000              200,000             300,000 Operating Income/(Loss)             (130,000)           1,700,000         1,570,000 When Propert Insurance is dropped Income statement Details Automobile Insurance Total Sales            10,560,000        10,560,000 Less Variable Expenses            8,448,000           8,448,000 Contribution Margin            2,112,000           2,112,000 Less Direct Fixed Expenses                500,000              500,000 Segment Margin            1,612,000           1,612,000 Less Common Fixed cost                300,000              300,000 Operating Income/(Loss)            1,312,000           1,312,000 Decrease in Net income=                258,000 So when Property Insurance is   dropped , the net income reduces by $258,000      2 Part 2 cannot be answered as the   Property insurance related advertise ment expense amount not given.

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