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.

	Basic	Countertop	Built-In	Total
Sales	$204,375	$865,375	$735,215	$1,804,965
Variable COGS	183,375	302,830	351,755	837,960
Commissions	4,150	42,465	36,045	82,660
Contribution margin	$16,850	$520,080	$347,415	$884,345
Separable fixed expense	29,085	74,345	176,000	279,430
Segment margin	$(12,235)	$445,735	$171,415	$604,915
Common fixed expenses:
Factory overhead				215,025
Selling and administrative expense				290,420
Operating income				$99,470

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 $- Select your answer -higherlowerItem 2 .

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 $ (round to the nearest dollar) - Select your answer -higherlowerItem 4 than if the Basic line is kept.