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Chapter 25: Q25-17RQ (page 1406)

Explain why a segment with an operating loss can cause the company to have a decrease in total operating income if the segment is dropped.

Short Answer

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Answer

Dropping a segment may lead to a decrease in total operating income if such a segment has a positive contribution margin.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Operating Income

Operating income refers tothe revenue generated by a business from its major functions. It includes the revenues generated from the sale and purchase of goods or services after deducting the related expenses.

02

Loss in a segment leading to a decrease in operating income

A dropped segment may lead to a decrease in total operating income if such a segment is has a positive contribution margin. There may be a situation where a segment has a positive contribution margin but has an operating loss. It means that such a segment is helping the company to recover some of its fixed costs, and dropping the segment will decrease the total operating income.

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Most popular questions from this chapter

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company president’s attention because he convinced the president to invest $3,000,000 in the machinery last year.

Explain what is relevant and irrelevant to Jacobs’s dilemma. What should he do?

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Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials \(500

Direct labor 1,000

Variable manufacturing overhead 200

Fixed manufacturing overhead 1,200

Total manufacturing cost \)2,900

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Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

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