KEEP OR DROP AudioMart is a retailer of radios, stereos, and televisions. The store carries two portable sound systems that have radios, tape players, and speakers. System A, of slightly higher quality than System B, costs $20 more. With rare exceptions, the store also sells a headset when a system is sold. The headset can be used with either system. Variable-costing income statements for the three products follow:

System A System B Headset Sales $45,000 $ 32,500 $8,000 Less: Variable expenses 20,000 25,500 3,200 Contribution margin $25,000 $ 7,000 $4,800 Less: Fixed costs* 10,000 18,000 2,700 Operating income $15,000 $(11,000) $2,100

*This includes common fixed costs totaling $18,000, allocated to each product in proportion to its revenues.

The owner of the store is concerned about the profit performance of System B and is considering dropping it. If the product is dropped, sales of System A will increase by 30 percent, and sales of headsets will drop by 25 percent.

Required:

. Prepare segmented income statements for the three products using a better format.

. Prepare segmented income statements for System A and the headsets assuming that System B is dropped. Should B be dropped?

. Suppose that a third system, System C, with a similar quality to System B, could be acquired. Assume that with C the sales of A would remain unchanged; however, C would produce only 80 percent of the revenues of B, and sales of the headsets would drop by 10 percent. The contribution margin ratio of C is 50 percent, and its direct fixed costs would be identical to those of B. Should System B be dropped and replaced with System C?

Problem