University:
California State University, Northridge
Course:
MGT 360 | Management and Organizational Behavior
Academic year:

2024
Views:

396

Pages:

21
Author:

Maia Holmes

Chapter 11 Relevant Costs for Decision Making 11-17 Learning Objective 2 Prepare an analysis showing whether a product line or other business segment should be dropped or retained. 11-18 Adding/Dropping Segments One of the most important decisions managers make is whether to add or drop a business segment, such as a product or a store. Let’s see how relevant costs should be used in this type of decision. 11-19 Adding/Dropping Segments Due to the declining popularity of digital watches, Lovell Company’s digital watch line has not reported a profit for several years. Lovell is considering discontinuing this product line. 11-20 A Contribution Margin Approach DECISION RULE Lovell should drop the digital watch segment only if its profit would increase. This would only happen if the fixed cost savings exceed the lost contribution margin. Let’s look at this solution. 11-21 Adding/Dropping Segments Segment Income Statement Digital Watches Sales Less: variable expenses Variable manufacturing costs Variable shipping costs Commissions Contribution margin Less: fixed expenses General factory overhead Salary of line manager Depreciation of equipment Advertising - direct Rent - factory space General admin. expenses Net operating loss $ 120,000 5,000 75,000 $ 60,000 90,000 50,000 80,000 70,000 30,000 $ 500,000 $ 200,000 300,000 $ 380,000 (80,000) 11-22 Adding/Dropping Segments Segment Income Statement Digital Watches Sales 500,000 An investigation has revealed that total$ fixed Less: variable expenses general factory overhead and general Variable manufacturing costs $ 120,000 Variable shipping costs 5,000be affected if administrative expenses would not Commissions 75,000 200,000 the digital watch line is dropped. The fixed Contribution margin $ 300,000 general factory overhead and general Less: fixed expenses General factory expenses overhead assigned $ 60,000 administrative to this product Salary of be line reallocated manager would to other90,000 product lines. Depreciation of equipment 50,000 Advertising - direct 80,000 Rent - factory space 70,000 General admin. expenses 30,000 380,000 Net operating loss $ (80,000) 11-23 Adding/Dropping Segments Segment Income Statement Digital Watches Sales $ 500,000 Less: variable expenses The equipment usedcosts to manufacture Variable manufacturing $ 120,000 Variable shipping costshas no resale 5,000 digital watches Commissions 75,000 200,000 value or alternative use. Contribution margin $ 300,000 Less: fixed expenses General factory overhead $ 60,000 Salary of line manager 90,000 Depreciation of equipment 50,000 retain or drop Should Lovell Advertising - direct 80,000 the digital watch segment? Rent - factory space 70,000 General admin. expenses 30,000 380,000 Net operating loss $ (80,000) 11-24 A Contribution Margin Approach Contribution Margin Solution Contribution margin lost if digital watches are dropped Less fixed costs that can be avoided Salary of the line manager Advertising - direct Rent - factory space Net disadvantage $ $ (300,000) 90,000 80,000 70,000 $ 240,000 (60,000) Lovell should retain the digital watch segment. 11-25 Comparative Income Approach The Lovell solution can also be obtained by preparing comparative income statements showing results with and without the digital watch segment. Let’s look at this second approach. 11-26 Comparative Income Approach Solution Keep Drop Digital Digital Difference Watches Watches Sales $ 500,000 $ $ (500,000) Less variable expenses: Manufacturing expenses 120,000 120,000 Shipping 5,000 5,000 Commissions 75,000 75,000 Total variable expenses 200,000 200,000 Contribution margin 300,000 (300,000) Less fixed expenses: General factory overhead 60,000 Salary of line manager 90,000 Depreciation 50,000 If the digital watch Advertising - direct 80,000 line is dropped, Rent - factory space 70,000 the company gives General admin. expenses 30,000 Total fixed expenses 380,000 up its contribution Net operating loss $ (80,000) Comparative Income Approach margin. 11-27 Comparative Income Approach Solution Keep Drop Digital Digital Difference Watches Watches Sales $ 500,000 $ $ (500,000) Less variable expenses: Manufacturing expenses 120,000 120,000 Shipping 5,000 5,000 Commissions 75,000 75,000 Total variable expenses 200,000 200,000 Contribution margin 300,000 (300,000) Less fixed expenses: General factory overhead 60,000 60,000 Salary of line manager 90,000 Depreciation 50,000 On the other hand, the general Advertising - direct 80,000 Rent - factory space 70,000 factory overhead would be the General admin. expenses 30,000 same. So this cost really isn’t Total fixed expenses 380,000 Net operating loss $ (80,000) relevant. Comparative Income Approach 11-28 Comparative Income Approach Solution Keep Drop Digital Digital Watches Watches Sales $ 500,000 $ Less variable expenses: But we wouldn’t need a Manufacturing expenses 120,000 manager for5,000 the product -line Shipping Commissions 75,000 anymore. Total variable expenses 200,000 Contribution margin 300,000 Less fixed expenses: General factory overhead 60,000 60,000 Salary of line manager 90,000 Depreciation 50,000 Advertising - direct 80,000 Rent - factory space 70,000 General admin. expenses 30,000 Total fixed expenses 380,000 Net operating loss $ (80,000) Comparative Income Approach Difference $ (500,000) 120,000 5,000 75,000 200,000 (300,000) 90,000 11-29 Comparative Income Approach Solution Keep Drop Digital Digital Difference Watches Watches Sales $ 500,000 $ $ (500,000) If variable the digital watch line is dropped, the net -book value Less expenses: Manufacturing expenseswould be written 120,000 off. The depreciation 120,000 of the equipment Shipping 5,000 5,000 that would have been taken will flow through the Commissions 75,000 75,000 Total variable expenses 200,000 200,000 income statement as a loss. Contribution margin 300,000 (300,000) Less fixed expenses: General factory overhead 60,000 60,000 Salary of line manager 90,000 90,000 Depreciation 50,000 50,000 Advertising - direct 80,000 Rent - factory space 70,000 General admin. expenses 30,000 Total fixed expenses 380,000 Net operating loss $ (80,000) Comparative Income Approach 11-30 Comparative Income Approach Solution Keep Drop Digital Digital Watches Watches Sales $ 500,000 $ Less variable expenses: Manufacturing expenses 120,000 Shipping 5,000 Commissions 75,000 Total variable expenses 200,000 Contribution margin 300,000 Less fixed expenses: General factory overhead 60,000 60,000 Salary of line manager 90,000 Depreciation 50,000 50,000 Advertising - direct 80,000 Rent - factory space 70,000 General admin. expenses 30,000 30,000 Total fixed expenses 380,000 140,000 Net operating loss $ (80,000) $ (140,000) Difference $ (500,000) 120,000 5,000 75,000 200,000 (300,000) 90,000 80,000 70,000 240,000 $ (60,000) 11-31 Beware of Allocated Fixed Costs Why should we keep the digital watch segment, when it’s showing a $80,000 loss? 11-32 Beware of Allocated Fixed Costs The answer lies in the way we allocate common fixed costs to our products. 11-33 Beware of Allocated Fixed Costs Our allocations can make a segment look less profitable than it really is. In fact, dropping the product line would decrease our overall net operating income. 11-34 Segment Margin Revenue Less traceable costs Segment margin Let’s revisit the Digital Watches line to evaluate its segment margin. 11-35 Segment Margin Segment Income Statement Digital Watches Sales $ 500,000 Less: variable expenses Variable manufacturing costs $ 120,000 is Variable shippingThe costssegment margin 5,000 Commissions $10,000, so the product 75,000 line200,000 Contribution margin should be retained. $ 300,000 Less: traceable fixed expenses Salary of line manager $ 90,000 Advertising - direct 80,000 Rent - factory space 70,000 Depreciation of equipment 50,000 $ 290,000 Segment margin $ 10,000 Less: common fixed expenses General factory overhead $ 60,000 General admin. expenses 30,000 90,000 Net operating loss $ (80,000) 11-36 Segment Margin Segment Income Statement Digital Watches the $50,000 When Sales sunk cost is added to Less: variable expenses the $10,000 segment Variable manufacturing costs margin, it yields Variable shipping costs a Commissions $60,000 net income Contribution margin that would be realized Less: traceable fixed expenses by retaining Digital Salary of line manager Watches. Advertising - direct Rent - factory space Depreciation of equipment Segment margin Less: common fixed expenses General factory overhead General admin. expenses Net operating loss $ 120,000 5,000 75,000 $ $ 90,000 80,000 70,000 50,000 60,000 30,000 $ 500,000 200,000 $ 300,000 $ 290,000 $ 10,000 $ 90,000 (80,000)