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Chapter 25: Q25-4SE (page 1408)

Edna Fashions operates three departments: Men’s, Women’s, and Accessories. Departmental operating income data for the third quarter of 2018 are as follows:

EDNA FASHIONS

Income Statement

For the Quarter Ended September 30, 2018

Department

Men’s Women’s Accessories Total

Net Sales Revenue \(101,000 \)59,000 \(102,000 \)262,000

Variable Costs 65,000 35,000 91,000 191,000

Contribution Margin 36,000 24,000 11,000 71,000

Fixed Costs 27,000 19,000 29,000 75,000

Operating Income \(9,000 \)5,000 \((18,000) \)(4,000)

Assume that the fixed costs assigned to each department include only direct fixed costs of the department:

• Salary of the department’s manager

• Cost of advertising directly related to that department

If Edna Fashions drops a department, it will not incur these fixed costs. Under these circumstances, should Edna Fashions drop any of the departments? Give your reasoning.

Short Answer

Expert verified

Answer

Edna Fashions shoulddrop its accessories department.

Step by step solution

01

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

Operating income refers to the income generated by a business from its major operations, such as revenues from sales. It is computed after deducting the variable and fixed costs from the net sales revenues.

02

Decision on continuing or dropping a segment

The decision to drop a segment is based on several factors, such as savings of variablecosts and loss of revenuesif a business drops a segment.

In the given scenario, the decision of dropping or continuing a segment is based on the incremental income/(loss).

If a business segment is generating income after deducting all the variable and fixed costs from the sales revenue, then such a segment should be continued.

As per the given data, the Men’s and Women’s department is generating revenues after recovering all the associated costs; hence the same should be carried forward.

In addition, the accessories section of the company is incurring losses, i.e., not in a state to cover associated costs. Therefore, the company should drop this segment because it is affecting the overall operating income.

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Most popular questions from this chapter

Each morning, Max Smith stocks the drink case at Max’s Beach Hut in Myrtle Beach, South Carolina. The drink case has 120 linear feet of refrigerated drink space. Each linear foot can hold either six 12-ounce cans or three 20-ounce bottles.

Max’s Beach Hut sells three types of cold drinks:

1. Licious-Ade in 12-oz. cans for \(1.40 per can

2. Licious-Ade in 20-oz. bottles for \)1.90 per bottle

3. Pep-Cola in 20-oz. bottles for \(2.20 per bottle

Max’s Beach Hut pays its suppliers:

1. \)0.20 per 12-oz. can of Licious-Ade

2. \(0.35 per 20-oz. bottle of Licious-Ade

3. \)0.55 per 20-oz. bottle of Pep-Cola

Max’s Beach Hut’s monthly fixed costs include:

Hut rental \(355

Refrigerator rental 65

Max’s salary 1,700

Total fixed costs \)2,120

Max’s Beach Hut can sell all the drinks stocked in the display case each morning.

Requirements

1. What is Max’s Beach Hut’s constraining factor? What should Max stock to maximize profits?

2. Suppose Max’s Beach Hut refuses to devote more than 80 linear feet to any individual product. Under this condition, how many linear feet of each drink should Max’s stock? How many units of each product will be available for sale each day?

Johnson Builders builds 1,500-square-foot starter tract homes in the fast-growing suburbs of Atlanta. Land and labor are cheap, and competition among developers is fierce. The homes are a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:

Land \(50,000

Construction 123,000

Landscaping 9,000

Variable selling costs 8,000

Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for \)207,000 each. Assume the company has no fixed costs.

Requirements

1. Which approach to pricing should Johnson Builders emphasize? Why?

2. Will Johnson Builders be able to achieve its target profit levels?

3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost \(16,000 per home but would enable Johnson Builders to increase the sales prices by \)28,000 per home.

(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?

Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

SEA BLUE

Income Statement

For the Month Ended December 31, 2018

Sales in units 32,000

Net Sales Revenue \(608,000

Variable Costs:

Manufacturing 96,000

Selling and Administrative 108,000

Total Variable Costs 204,000

Contribution Margin 404,000

Fixed Costs:

Manufacturing 124,000

Selling and Administrative 94,000

Total Fixed Costs 218,000

Operating Income \)186,000

Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision.

2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order.

3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.

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

Number of cakes ÷ 100

Cost per cake \(29

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.

  1. Should Grimm make the cakes or buy them? Why?
  2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

Moore Company sells both designer and moderately priced fashion accessories. Top management is deciding which product line to emphasize. Accountants have provided the following data:

Per Item

Designer Moderately Priced

Average sales price \(185 \)87

Average variable costs 105 22

Average contribution margin 80 65

Average fixed costs (allocated) 20 10

Average operating income \(60 \)55

The Moore Company store in Grand Junction, Colorado, has 14,000 square feet of floor space. If Moore Company emphasizes moderately priced goods, it can display 840 items in the store. If Moore Company emphasizes designer wear, it can display only 560 designer items. These numbers are also the average monthly sales in units.

Prepare an analysis to show which product the company should emphasize.
See all solutions

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