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 $375,000 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 16% 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 $ 4,350,000 $ 3,160,000 $ 1,190,000 Variable expenses 1,394,000 976,000 418,000 Contribution margin 2,956,000 2,184,000 772,000 Fixed expenses 2,230,000 1,390,000 840,000 Net operating income (loss) $ 726,000 $ 794,000 $ (68,000 )

Explanation / Answer

New Contribution margin for Hardware=$2,184,000(1-0.16)[Total sales would decrease;hence total variable cost would also decrease creating a decrease in Contribution margin]

=$1834560

Less:Fixed cost for Hardware=(1,390,000)

Net operating income for Hardware=$444,560

Less:Fixed costs for Linens=($375000)

New net operating income for total company=$69560.

Hence financial disadvantage=decrease in net operating income=(726000-69560)=$656,440.

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