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	$204,260	$865,505	$735,370	$1,805,135
Variable COGS	183,350	302,060	352,300	837,710
Commissions	4,295	43,880	36,865	85,040
Contribution margin	$16,615	$519,565	$346,205	$882,385
Separable fixed expense	30,890	75,555	174,365	280,810
Segment margin	$(14,275)	$444,010	$171,840	$601,575
Common fixed expenses:
Factory overhead				216,360
Selling and administrative expense				290,890
Operating income				$94,325

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.