A recent accounting graduate from The Applied Science Private University evaluated the
operating performance of ABC Company’s four divisions. The following presentation was made
to ABC’s Board of Directors. During the presentation, the accountant made the recommendation
to eliminate the YYY Division stating that total net income would increase by $60,000. (See
analysis below.)
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net Income
Other Three Divisions
$2,000,000
950,000
1,050,000
800,000
$ 250,000
YYY Division
$480,000
400,000
80,000
140,000
$ (60,000)
Total
$2,480,000
1,350,000
1,130,000
940,000
$ 190,000
For the other divisions, cost of goods sold is 80% variable and operating expenses are 70%
variable. The cost of goods sold for the YYY Division is 30% fixed, and its operating expenses
are 75% fixed. If the division is eliminated, only $15,000 of the fixed operating costs will be
eliminated.
Required
Do you concur with the new accountant’s recommendation? Present a schedule to support your
answer.
Solution
Sales
Cogs
Operating expenses
Total variable
Contribution margin
Fixed expenses
Cost of goods sold
Operating expenses
Total fixed
Net income (loss)
continue
480000
320000
98000
418000
62000
eliminate
0
0
0
0
Net income
(480000)
320000
98000
418000
(62000)
80000
42000
122000
(60000)
80000
27000
122000
(107000)
0
15000
0
$(47000)
The incremental analysis shows that net income will be $(47000) less if the YYY division is
eliminated .This amount not equals the Contribution margin that would be lost by discontinuing
division.