Exercise 17.24

Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis

Devern Assurance Company provides both property and automobile insurance. The projected income statements for the two products are as follows:

Property Insurance Automobile Insurance

Sales $4,200,000 $12,000,000

Less Variable Expenses 3,830,000 9,600,000

Contribution Margin $370,000 $2,400,000

Less Direct Fixed Expenses 400,000 500,000

Segment Margin $ (30,000) $1,900,000

Less Common Fixed Expenses 100,000 200,000

Operating Income (Loss) $ (130,000) $1,700,000

The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

1. As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

2.Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.