Keep-or-Drop Decisions A keep-or-drop decision uses relevant cost analysis to de
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Question
Keep-or-Drop Decisions
A keep-or-drop decision uses relevant cost analysis to determine whether a segment or line of business should be kept or dropped. In a traditional cost management system, segmented income statements, using unit-based fixed or variable costs, improve the ability to make keep-or-drop decisions.
Example: Ginger Company makes three types of microwave ovens. Basic is the small 0.7 cubic foot model sold at discount stores. Countertop is a larger (1.2 cubic foot) model with more advanced features. Built-in is a model designed to fit into cabinetry and is sold through appliance stores. A segmented income statement is shown below.
Ginger Company believes the basic model is a concern and is considering a number of options to deal with this situation. One possibility is to drop the Basic line. If that is done, operating income will be $ - Select your answer -higherlowerItem 2 .
After further study, Ginger Company has found that if the Basic Model is dropped, sales of the Countertop model will decrease by 5 percent as some stores prefer to order only from a company with both basic and countertop models. Now if the Basic line is dropped, operating income will be $ (round to the nearest dollar) - Select your answer -higherlowerItem 4 than if the Basic line is kept.
Basic Countertop Built-In Total Sales $204,260 $865,505 $735,370 $1,805,135 Variable COGS 183,350 302,060 352,300 837,710 Commissions 4,295 43,880 36,865 85,040 Contribution margin $16,615 $519,565 $346,205 $882,385 Separable fixed expense 30,890 75,555 174,365 280,810 Segment margin $(14,275) $444,010 $171,840 $601,575 Common fixed expenses: Factory overhead 216,360 Selling and administrative expense 290,890 Operating income $94,325Explanation / Answer
Ginger Company believes the basic model is a concern and is considering a number of options to deal with this situation. One possibility is to drop the Basic line. If that is done, operating income will be $ 14,275 Higher
After further study, Ginger Company has found that if the Basic Model is dropped, sales of the Countertop model will decrease by 5 percent as some stores prefer to order only from a company with both basic and countertop models. Now if the Basic line is dropped, operating income will be $ 11,703 lower than if the Basic line is kept.
Note :
One possibility is to drop the Basic line. If that is done, operating income will be increase by Segment margin Losse will be avoided i.e $ 14,275
After further study,
Countertop model will decrease by 5 percent
Operating Income Changes by = 14275 - Contribution margin of counter top*5%
Operating Income Changes by = 14275 - 519565*5%
Operating Income Changes by = -11703.25
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