AudioMart is a retailer of radios, stereos, and televisions. The store carries two portable sound system 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

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%, and sales of headsets will drop by 25%.

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

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

3: 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% of the revenues of B, and sales of the headsets would drop by 10%. The contribution margin ratio of C is 50%, and its direct fixed costs would be identical to those of B. Should System B be dropped and replaced with System C?