Question

Wonders Corporation has two departments, Kids and Adults. The company’s most recent monthly contribution format income statement follows:

		Department
	Total	Kids	Adults
Sales	$4,200,000	$3,000,000	$1,200,000
Variable expenses	2,000,000	1,500,000	500,000
Contribution Margin	2,200,000	1,500,000	700,000
Fixed Expenses	2,200,000	1,300,000	900,000
Net operating income (loss)	0	200,000	(200,000)

A study indicates that $250,000 of the fixed expenses being charged to the Adults Department are sunk costs or allocated costs that will continue even if the Adults Department is dropped. In addition, the elimination of the Adults Department will result in a 30% decrease in the sales of the Kids Department. If the Adults Department is dropped, what will be the effect on the net operating income of the company as a whole?

Multiple Choice

• Decrease by $470,000

• Decrease by $500,000

• Increase by $530,000

• Decrease by $530,000

Answer 1

a) Dropping Adult division will result into decrease in net operating income by $500,000 , therefore Adult division should not be dropped
Particulars	Kids	Adult	Total
Sales	$              21,00,000.00		$                 21,00,000.00
Variable cost	$              10,50,000.00		$                 10,50,000.00
Contribution margin	$              10,50,000.00		$                 10,50,000.00
Less: Avoidable Fixed expense	$                    13,00,000		$                       13,00,000
Less: Unavoidable Fixed expense		$                       2,50,000	$                          2,50,000
Net operating income/(Loss)	$                    (2,50,000)	$                    (2,50,000)	$                       (5,00,000)

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