Bed & Bath, a retailing company, has two departments—Hardware and Linens. The co

Question

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

A study indicates that $372,000 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 17% decrease in the sales of the Hardware Department.

Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Department Total Hardware Linens Sales $ 4,340,000 $ 3,190,000 $ 1,150,000 Variable expenses 1,271,000 870,000 401,000 Contribution margin 3,069,000 2,320,000 749,000 Fixed expenses 2,290,000 1,470,000 820,000 Net operating income (loss) $ 779,000 $ 850,000 $ (71,000 )

Explanation / Answer

Income statement if the linen department is dropped:

Variable expenses will reduce as they are directly linked to sales.

Variable Expenses ratio = (870000/3190000) x 100 = 27.27%

Sales (3190000-17%) 2,647,700 Variable Expenses (27.27% X 2647700) 722,100 Contribution Margin 1,925,600 Fixed Expenses 1,842,000 Net Operating Income 83,600 Previous NOI 779,000 Financial Disadvantage (695,400)

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