Question
Keep-or-Drop Decisions A keep-or-drop decision uses relevant cost analysis to determine whether a segment or line of business should be kept or dropped. In a
Keep-or-Drop Decisions
A keep-or-drop decision uses relevant cost analysis to determine whether a segment or line of business should be kept or dropped. In a traditional cost management system, segmented income statements, using unit-based fixed or variable costs, improve the ability to make keep-or-drop decisions.
Example: Ginger Company makes three types of microwave ovens. Basic is the small 0.7 cubic foot model sold at discount stores. Countertop is a larger (1.2 cubic foot) model with more advanced features. Built-in is a model designed to fit into cabinetry and is sold through appliance stores. A segmented income statement is shown below.
Sales | $203,305 | $864,700 | $734,935 | $1,802,940 |
Variable COGS | 184,975 | 302,845 | 351,875 | 839,695 |
Commissions | 4,815 | 42,290 | 36,600 | 83,705 |
Contribution margin | $13,515 | $519,565 | $346,460 | $879,540 |
Separable fixed expense | 29,560 | 75,345 | 174,255 | 279,160 |
Segment margin | $(16,045) | $444,220 | $172,205 | $600,380 |
Common fixed expenses: | ||||
Factory overhead | 216,165 | |||
Selling and administrative expense | 289,450 | |||
Operating income | $94,765 |
Ginger Company believes the basic model is a concern and is considering a number of options to deal with this situation. One possibility is to drop the Basic line. If that is done, operating income will be $ ANSWER ,( HIGHER OR LOWER)
.
After further study, Ginger Company has found that if the Basic Model is dropped, sales of the Countertop model will decrease by 5 percent as some stores prefer to order only from a company with both basic and countertop models. Now if the Basic line is dropped, operating income will be $ ANSWER (round to the nearest dollar)
(HIGHER OR LOWER)than if the Basic line is kept.
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