Keep or Drop

AudioMart is a retailer of vintage vinyl records and equipment. The store carries two popular sound systemsSystem A and System B. System A, of slightly higher quality than System B, costs $20 more. With rare exceptions, the store also sells a specialized headset when a system is sold. The headset can be used with either system. Variable-costing income statements for the three products follow:

Line Item Description	System A	System B	Headset
Sales	$45,200	$32,200	$8,100
Less: Variable expenses	20,500	25,900	2,700
Contribution margin	$24,700	$6,300	$5,400
Less: Fixed costs *	10,300	17,500	2,600
Operating income (loss)	$14,400	$(11,200)	$2,800

*This includes common fixed costs totaling $17,500, 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 28%, and sales of headsets will drop by 25%. Round all answers to the nearest whole number.

Required:

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

Line Item Description	System A	System B	Headset	Total
Contribution marginOperating incomeSalesSegment marginSales	$Sales	$Sales	$Sales	$Sales
Add: Variable expensesLess: Variable expensesLess: Variable expenses	Less: Variable expenses	Less: Variable expenses	Less: Variable expenses	Less: Variable expenses
Contribution marginDirect laborOperating incomeSegment marginContribution margin	$Contribution margin	$Contribution margin	$Contribution margin	$Contribution margin
Add: Direct fixed costLess: Direct fixed costLess: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost
Contribution marginDirect laborSalesSegment marginSegment margin	$Segment margin	$Segment margin	$Segment margin	$Segment margin
Add: Common fixed costLess: Common fixed costLess: Common fixed cost				Less: Common fixed cost
Contribution marginDirect laborOperating incomeSalesOperating income				$Operating income

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Partially correct

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2(a) Conceptual Connection: 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.)

Line Item Description	System A	Headset	Total
Contribution marginOperating incomeSalesSegment marginSales	$Sales	$Sales	$Sales
Add: Variable expensesLess: Variable expensesLess: Variable expenses	Less: Variable expenses	Less: Variable expenses	Less: Variable expenses
Contribution marginDirect laborOperating incomeSegment marginContribution margin	$Contribution margin	$Contribution margin	$Contribution margin
Add: Direct fixed costLess: Direct fixed costLess: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost
Contribution marginDirect laborSalesSegment marginSegment margin	$Segment margin	$Segment margin	$Segment margin
Add: Common fixed costLess: Common fixed costLess: Common fixed cost			Less: Common fixed cost
Contribution marginDirect laborOperating incomeSalesOperating income			$Operating income

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Partially correct

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2(b) Should system B be dropped?

YesNoYes

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Correct

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Conceptual Connection: 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.)

Line Item Description	System A	System C	Headset	Total
Contribution marginOperating incomeSalesSegment marginSales	$Sales	$Sales	$Sales	$Sales
Add: Variable expensesLess: Variable expensesLess: Variable expenses	Less: Variable expenses	Less: Variable expenses	Less: Variable expenses	Less: Variable expenses
Contribution marginDirect laborOperating incomeSegment marginContribution margin	$Contribution margin	$Contribution margin	$Contribution margin	$Contribution margin
Add: Direct fixed costLess: Direct fixed costLess: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost	Less: Direct fixed cost
Contribution marginDirect laborSalesSegment marginSegment margin	$Segment margin	$Segment margin	$Segment margin	$Segment margin
Add: Common fixed costLess: Common fixed costLess: Common fixed cost				Less: Common fixed cost
Contribution marginDirect laborOperating incomeSalesOperating income				$Operating income

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3(b) Should System B be dropped and replaced with System C? The best option is to

keep Bdrop B without replacing with Creplace C with Bdrop B without replacing with C

.