Question

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

				Department
	Total			Hardware			Linens
Sales	$	4,130,000		$	3,020,000		$	1,110,000
Variable expenses		1,293,000			880,000			413,000
Contribution margin		2,837,000			2,140,000			697,000
Fixed expenses		2,200,000			1,400,000			800,000
Net operating income (loss)	$	637,000		$	740,000		$	(103,000	)

A study indicates that $375,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 13% decrease in the sales of the Hardware Department.

Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

Answer

It is mentioned that there will be 13% decrease in sales of Hardware Department if Linens Department is closed.

So if we will lose 13% of sales, that means we will Loss 13% Contribution Margin of Hardware store.

And it is mentioned that $375,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. So the remaining $425,000 (800,000 – 375,000) will still incur if we close the unit.

Contribution Margin loss of Hardware ($2,837,000 * 13%)	368,810
Contribution Margin loss of Linens	697,000
Total Contribution Loss	1,065,810
Add: Fixed Cost which can be avoided	(425,000)
Net Loss if we close the Unit	640,810

Financial Disadvantage if we close this Unit = $640,810

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