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 (loss)	$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%, and sales of headsets will drop by 25%. Round all answers to the nearest whole number.

Required:

1. Prepare segmented income statements for the three products. Round your answers to the nearest dollar. Input expenses as positive numbers.

AudioMart
Segmented Income Statement
System A, System B, and Headset
	System A	System B	Headset	Total
*Choices* Contribution Margin Operating Income Sales Segment Margin	$	$	$	$
*Choices* Add Variable Expenses Less Variable Expenses
*Choices* Contribution Margin Direct Labor Operating Income Segment Margin	$	$	$	$
*Choices* Add Direct fixed cost Less Direct fixed cost
*Choices* Contribution Margin Direct Labor Sales Segment Margin	$	$	$	$
*Choices* Add common fixed cost Less common fixed cost
*Choices* Contribution Margin Direct Labor Sales Operating Income				$

2(a) Prepare segmented income statements for System A and the headsets assuming that System B is dropped. Round your answers to the nearest dollar. Input expenses as positive numbers. (Note: Be sure to complete 2(b) below the statement.)

AudioMart
Segmented Income Statement
System A and Headset
	System A	Headset	Total
*Choices* Contribution Margin Operating Income Sales Segment Margin	$	$	$
*Choices* Add Variable Expenses Less Variable Expenses
*Choices* Contribution Margin Direct Labor Operating Income Segment Margin	$	$	$
*Choices* Add Direct fixed cost Less Direct fixed cost
*Choices* Contribution Margin Direct Labor Sales Segment Margin	$	$	$
*Choices* Add common fixed costs Less common fixed costs
*Choices* Contribution Margin Direct Labor Sales Operating Income			$

2(b) Should system B be dropped? A. Yes B. No

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.

3(a) Prepare segmented income statements for System A, System C and the headsets. Round your answers to the nearest dollar. Input expenses as positive numbers. (Note: Be sure to complete 3(b) below the statement.)

AudioMart
Segmented Income Statement
System A, System C, and Headset
	System A	System C	Headset	Total
*Choices* Contribution Margin Operating Income Sales Segment Margin	$	$	$	$
*Choices* Add variable expenses Less variable expenses
*Choices* Contribution Margin Direct Labor Operating Income Segment Margin	$	$	$	$
*Choices* Add Direct Fixed Cost Less Direct Fixed Cost
*Choices* Contribution Margin Direct Labor Sales Segment Margin	$	$	$	$
*Choices* Add Common fixed cost Less Common fixed cost
*Choices* Contribution Margin Direct Labor Sales Operating Income				$

3(b) Should System B be dropped and replaced with System C?

The best option is to

A) Keep B

B) Drop B without replacing C

C) Replace C with B