Dropping a product line (Learning Objective 4)

Suppose Kellogg’s is considering dropping its Special-K product line. Assume that dur¬ ing the past year, Special-K’s product line income statement showed the following:

Fixed manufacturing overhead costs account for 40% of the cost of goods, while only 30% of the operating expenses are fixed. Since the Special-K line is only one of Kellogg’s breakfast cereals, only $750,000 of direct fixed costs (the majority of which is advertising) will be eliminated if the product line is discontinued. The remainder of the fixed costs will still be incurred by Kellogg’s. If the company decides to drop the product line, what will happen to the company’s operating income? Should Kellogg’s drop the product line?

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Sales Cost of goods sold....... Gross profit............ Operating expenses Operating loss... $7,600,000 6,400,000 1,200,000 1,400,000 $ (200,000)