Question

Smith Industries suffered an operating loss of $10,000 ($100,000 revenues minus $110,000 total expenses) on its widget division and is considering its elimination. The widget division’s expenses include $30,000 in allocated expenses that were shared with other departments and cannot be avoided if the widget division is eliminated. Determine the incremental gain or loss if Johnson eliminates its widget division.

Answer 1

If widget division is eliminated. Total revenue will drop by $100,000, resulting in a decline in total profit. Direct costs of $80,000 are directly associated with widget division and will be avoided. This decrease in direct costs is a saving which increases profits. Allocated costs must be absorbed by other departments if widget division is eliminated, so there will be no change to allocated costs for the entire company. Computation of incremental gain or loss. Incremental revenue: $100,000, Incremental savings: $80,000