University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

466

Pages:

2
Author:

stud_ice13

Key Concepts for Segment Elimination Decisions 1. Contribution Margin vs. Avoidable Costs: o The contribution margin is the segment's revenue minus its variable costs. o Avoidable costs are costs that disappear when the segment is eliminated (e.g., variable costs and direct fixed costs specific to the segment). o A segment should be kept if its contribution margin is greater than avoidable costs, as this means it contributes positively to the overall income. If the contribution margin is less than the avoidable costs, the segment might be a candidate for elimination. 2. Unavoidable Costs: o Some costs will persist even if a segment is eliminated. These are unavoidable costs and will be reallocated to the remaining segments. o Decision-makers must carefully identify and separate avoidable and unavoidable costs to assess the true impact of eliminating a segment. 3. Impact on Total Income: o Elimination should ideally increase the company’s overall income. If eliminating a segment reduces total income, it should be retained. o In the example from FasTrac, eliminating the Treadmill segment was considered because it showed a loss. However, the analysis revealed that the segment’s contribution margin exceeded avoidable fixed costs, and the unavoidable costs would reduce overall income. Hence, the segment was retained to avoid a $1,000 decrease in income. Decision Rule • • Keep the Segment if eliminating it decreases overall income (i.e., the contribution margin exceeds avoidable costs). Eliminate the Segment if overall income increases by eliminating it (i.e., avoidable costs savings exceed the lost contribution margin). Example Cases • • FasTrac's Treadmill Segment: The Treadmill segment had a $5,000 contribution margin with $4,000 in avoidable fixed costs and $11,000 in unavoidable costs. Eliminating the segment would result in a $1,000 decrease in total income, so it was decided to keep the segment. Bike Maker's Tandem Division: The Tandem Bike division had a $10,000 contribution margin, but eliminating it would save $12,000 in avoidable fixed costs. This led to a $2,000 increase in total income, justifying the decision to eliminate the division. Analysis Tools • Exhibit Comparisons: o Exhibit 23.8: Shows current segment performance, highlighting contribution margins and avoidable vs. unavoidable costs. o Exhibit 23.9: Displays income after segment elimination, illustrating the impact on total income. o Exhibit 23.10: Provides a breakdown of the change in income if a segment is eliminated, confirming the decision with a clear comparison between keeping and eliminating. Conclusion Effective segment elimination decisions rely on accurate analysis of contribution margins, avoidable costs, and the overall effect on total income. This approach helps management to maintain or increase profitability by only eliminating segments that do not contribute positively to the company’s financial health.