McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total Product A Product B

Net Sales Revenue \(150,000 \)75,000 \(75,000

Variable Costs 90,000 55,000 35,000

Contribution Margin 60,000 20,000 40,000

Fixed Costs 50,000 5,000 45,000

Operating Income/(Loss) \)10,000 \(15,000 \)(5,000)

1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

Step by step solution

01

Meaning of Operating Income

Operating income refers to the amount of money left with a business entity after the settlement of all the variable and fixed costs associated with a product's sales process. Operating income includes the core operations of an entity.

02

Decision of dropping the product

The company should drop product B because it incurslosses tothecompany and decreases the overalloperating incomeof theproduct line.Hence, the product should be dropped iffixed costscannot be avoided.

03

Decision taken in case fixed cost can be avoided

Particulars	Amount ($)
Net sales revenue	75,000
Less: Variable costs	(35,000)
Contribution margin	40,000
Less: Fixed costs (45,000*50%)	(22,500)
Operating income	$17,500

The company should keep product B in its product line if the fixed costs associated with the same are 50% avoidable. This will generate revenues for the company and result in an overall increase in the product line’s operating income.

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