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 $378,000 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 11% 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 $ 4,070,000 $ 3,060,000 $ 1,010,000 Variable expenses 1,382,000 962,000 420,000 Contribution margin 2,688,000 2,098,000 590,000 Fixed expenses 2,200,000 1,320,000 880,000 Net operating income (loss) $ 488,000 $ 778,000 $ (290,000 )

Explanation / Answer

Contribution margin ratio for Hardware=(Contribution margin/Sales)

=(2098000/3060000)=0.6856

New sales for Hardware=3060000(1-0.11)=$2723400

New Contribution margin for Hardare=(2723400*0.6856)=$1867220

Less:Fixed costs for Hardware=$1,320,000

Less:Fixed costs for Linens=$378000

New net operating income=$169220

Hence decrease in net operating income=(488000-169220)=$318780.

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