3 Add or drop a segment: look at slides (1) An investigation has revealed that the fixed general factory overhead and fixed general administrative expenses will not be affected by dropping the digital watch (2) The equipment used to manufacture digital watches has no resale value or alternative use. Should Lovell retain or drop the digital watch segment? Comparative Income Approach Keep Digital Watches $ 500,000 Drop Digital Watches $ Difference $ (500,000 120,000 5,000 75,000 200,000 300.000 120,000 5,000 75,000 200,000 (300,000) Sales Less variable expenses: Manufacturing expenses Shipping Commissions Total variable expenses Contribution margin Less fixed expenses: General factory overhead Salary of line manager Depreciation Advertising - direct Rent - factory space General admin. expenses Total fixed expenses Net operating loss - know. Lovell's managers may ask: "Why should we keep the digital watch segment when it's showing a $100,000 loss?" Be aware that allocated fixed costs can distort the keep/drop decision. Including unavoidable common fixed costs makes the product line appear to be unprofitable, when in fact dropping the product line would decrease the company's overall net operating People have a tendency to assume that if a cost is traceable to a segment, then the cost is automatically avoidable, which is untrue. Before making a decision, managers must decide which of the potentially relevant costs are actually avoidable. 60,000 90,000 50,000 60,000 90,000 50,000 100,000 70,000 30,000 400,000 $ (100,000) 100,000 70,000 30,000 140,000 $ (140,000) 260,000 (40,000) $ 4 Make or buy Essex Company manufactures part 4A that is used in one of its products. The unit product cost of this part 4A is: The special equipment used to manufacture part 4A has no resale value. Direct materials Direct labor Variable overhead The total amount of general factory overhead, which is allocated on the basis of direct labor hours, would be Depreciation of special equip. unaffected by this decision. Supervisor's salary General factory overhead The $30 unit product cost is based on 20,000 parts produced each year. Unit product cost An outside supplier has offered to provide the 20,000 parts at a cost of $25 per part. ONW Should the company stop making part 4A and buy it from an outside supplier? Make Buy To know Although depreciation/overhead is ALLOCATED to each product 4A, they don't go away if dropping product 4A they just get rellocated. The total amount of fixed overhead does not change